Long duration continues to dominate

Once again, long-duration bonds continue to reign supreme among the best performing fixed-income strategies for the year ended June 30, accounting for all 10 of the top performers, according to Morningstar Inc.'s separate account/collective investment trust database.

Long-duration bonds also took all 10 spots for the year ended March 31.

Long-duration government bond strategies made up the top seven spots for the year ended June 30 as Treasury yields remained low. Taking up the other three spots on the top 10 were strategies dealing with municipal national long-duration bonds, inflation-protected bonds and long-term bonds.

"If the theme of Q1 was a flight to safety, in Q2 it was just about the opposite," said Gabriel Denis, analyst for fixed-income strategies at Morningstar in Chicago.

While COVID-19 led investors to seek safe assets such as U.S. Treasuries and agency mortgages in Q1, Mr. Denis said a combination of factors ranging from investor optimism in the development of coronavirus vaccine to the federal government's and Federal Reserve's "kitchen sink approach" to boost markets had investors seeking riskier assets such as investment-grade and high-yield corporate bonds in the second quarter.

"While safe-haven assets such as U.S. Treasuries and agency mortgages were the big winners of Q1, they underperformed this (past) quarter," Mr. Denis said. "There was a lot of activity with riskier assets, such as investment-grade corporates. High-yield corporates also had major positive returns."

Still, Mr. Denis pointed out that long government bond strategies still accounted for so many of the top 10 slots for the year ended June 30 because they performed so well in the first quarter and didn't lose money in the second quarter. And while riskier strategies like investing in corporate credit and emerging market debt outperformed in the second quarter, many of the strategies took such significant losses in Q1 that they still lagged their long government peers on a 12-month basis.

During the first quarter, the coronavirus caused Treasury yields to decline, investment-grade and high-yield credit spreads to widen and the stock market to plummet. Tension between Saudi Arabia and Russia also resulted in plummeting oil prices.

But with President Donald Trump signing the $2.2 trillion Coronavirus Aid, Relief, and Economic Security Act on March 27 and the Federal Reserve offering some aggressive monetary programs at the end of Q1, things took a turn. Markets rallied. Investment-grade and high-yield spreads tightened. And after Saudi Arabia and Russia called a truce and OPEC agreed to limit production in April, oil prices rose again.

The Bloomberg Barclays U.S. Long-Government Bond index returned 25.41% for the year ended June 30; the Bloomberg Barclays U.S. Aggregate Bond index had a one-year return of 8.74%; the Bloomberg Barclays Global Aggregate ex-U.S. Bond index returned 0.71% for the year; and the Bloomberg Barclays U.S. Long-Duration Corporate Bond index ended the quarter with a 13.79% return for the one-year period.

Mr. Denis also noted that most of the big bounce in the quarter came in April.

And while markets and oil prices rebounded, Treasury yields remained low over the course of the second quarter.

"Those actions by the Fed have led the market to acknowledge that Treasury interest rates are low and may stay low for an extended period," noted Joe Murphy, director of portfolio management at NISA Investment Advisors LLC in St. Louis.

Meanwhile, municipal bonds "took a bit longer to recover," according to Mr. Denis. He attributed this to there being more uncertainty within the muni market. "There are more factors to consider in a socially distant, locked down world," the Morningstar analyst said.

Looking forward, a lot is riding on how the recovery develops.

"We are not out of this pandemic," Mr. Denis said. "The big question is how is this pandemic recovery going to go, what levels of stimulus from the U.S. government are needed, and if a vaccine comes, how will it look?"

For the year ended June 30, the median return for long-duration domestic strategies in Morningstar's universe was 17.74% and the median return for Morningstar's entire domestic fixed-income universe was 5.47%.

New York-based 16th Amendment Advisors LLC's Vicksburg U.S. muni national long strategy topped both the one- and five-year lists of returns, returning a gross 46.01% for the year ended June 30 and 35.78% for the five years ended the same date.

Aegon USA Investment Management LLC's Long U.S. Treasury STRIPS strategy — the top performer in Q1 — moved down one spot on Morningstar's list of top performers for the year ended June 30 to No.2, posting a gross return of 35.88%.

Third on the list of top performers was Barrow, Hanley, Mewhinney & Strauss, whose extended duration bond fund returned 34.5% for the year ended June 30.

Scott McDonald, managing director and fixed income portfolio manager at Barrow Hanley, attributed the strategy's outsized returns to the decline in U.S. Treasury rates.

Mr. McDonald also noted that the firm actively manages the strategy. This means that although Treasury STRIPS are in an efficient market, "sometimes some anomalies pop up in pricing that we can take advantage of."

"We're duration-neutral, but we look at the curve," Mr. McDonald added.

The Barrow Hanley portfolio manager pointed out that the firm's STRIPS strategy is one many of its pension plan clients use to help hedge against their liabilities.

Barrow Hanley's extended duration strategy ranked second among the five-year winners, returning 12.78% for the five years ended June 30.

NISA's 15+ STRIPS fixed-income composite ranked fourth and third on the one- and five-year lists for the second quarter, respectively, with a gross one-year return of 34.28% and a gross annualized 12.43% return for the five years ended June 30.

Mr. Murphy explained that long-maturity STRIPS have done exceptionally well since interest rates have fallen over the past few years. "30-Year Treasury rates fell approximately 110 basis points from the beginning of the year to the end of March," he said. "This led to significant returns for long-term STRIPS."

Mr. Murphy added that the "vast majority" of the $66 billion that the firm manages in STRIPS (is) on behalf of defined benefit plans looking to hedge the interest rate sensitivity in their liabilities.

Hoisington Investment Management Co.'s macroeconomic fixed-income composite came in fifth place on the one-year list, returning a gross 29.96% for the 12 months ended June 30.

"We're duration managers, and when we came into the year, we felt the economy was softening and inflation rate was lowering last year," said Lacy Hunt, chief economist at Hoisington in Austin. "Then when the pandemic struck, we thought it would enforce those trends."

Mr. Hunt said the firm uses the Fisher equation, which estimates the relationship between nominal and real interest rates under inflation, and deploys a multiyear strategy when investing.

"We believe the short-term fluctuations in the Treasury market reflect a lot of psychological factors and volatility, but do not create very long-lasting influences," he said. "So, we try to look beyond the noise of the day to day, week to week, quarter to quarter and follow these long-term fundamentals."

In terms of the remaining winners on the five-year list, Pacific Investment Management Co.'s Long Bond Extended Duration strategy returned a gross 11.98%, which put it in fourth place for the five-year period; and Hillswick Asset Management Inc.'s Long Duration Government strategy coming in fifth, returning 10.36%.

The median return for all domestic fixed-income strategies for the five years ended June 30 was 3.99%.

Fidelity Institutional Asset Management's Long U.S. Treasury STRIPS Pool index topped Morningstar's domestic collective investment trust universe for the one- and five-year periods ended June 30, with a net 38.24% and a net annualized 13.28%, respectively.

T. Rowe Price Group Inc.'s U.S. Treasury Long-Term Index trust ranked second on the one-year list, with a net 27.7%, while its U.S. Treasury Long-Term Index Trust-Z ranked third, returning a net 26.15%. BlackRock Inc.'s 20+ Treasury Bond Fund came in fourth on the one-year list and third on the five-year, returning a net 25.9% and 9.63%, respectively.

Meanwhile, BlackRock's long government bond index fund ranked fifth among CITs for the year ended June 30, returning a net 25.48%.

Wellington Management Co. LLP's CIF II Long Bond strategy ranked second on Morningstar's domestic CIT universe for the five years ended June 30, with a net 9.81%, while Wellington's CIF II U.S. Investment Grade Corporate Long Bond came in fourth place, with a net 9.41% return. Closing out the top five for the five-year list is State Street Global Advisors' U.S. Long Treasury Index Non-Lending Class A fund, returning a gross annualized 9.32%.

All data for Pensions & Investments' top-performing managers report are provided from Morningstar's global separate account/collective investment trust database. The data for the rankings on which this story is based were pulled Aug. 5.