Long-duration government bond funds take top spots following plunge in yields

Long-duration bond strategies continued to dominate the list of top-performing fixed-income strategies for the year ended March 31, claiming all of the top 10 spots, according to Morningstar Inc.'s separate account/collective investment trust database.

One high-yield strategy was on the list for the year ended Dec. 31, while long-term strategies filled the other nine spots at the end of 2019.

Long government bond strategies made up the top six spots for the year ended March 31 as Treasury yields plummeted in the latest quarter due to the COVID-19 pandemic.

"The overall feeling around Q1 2020 is that it's a major reversal of the optimism that we were starting to get toward the end of 2019," said Gabriel Denis, analyst for fixed-income strategies at Morningstar in Chicago.

Mr. Denis said the general sentiment of economic optimism at the end of 2019 continued into the beginning of 2020, buoyed by the U.S. and China signing the first phase of a trade agreement in January.

"After that period of calm, we started to see the second, really defining part of this quarter, which was the swift and all-encompassing economic collapse around the world, with the markets assessing just how bad the coronavirus was going to be, both on a human scale and on an economic scale," he said.

In addition to concerns related to the COVID-19 virus, Mr. Denis said the collapse of oil prices, largely driven by a dispute between Saudi Arabia and Russia, resulted in further economic uncertainty and led investors to buy safe-haven assets, such as U.S. Treasury bonds.

"As investors started to assess how bad things were getting because of coronavirus shutdowns, and especially when the oil price war took off, investors started to sell just about every asset that they could to enter into safe-haven assets. And as in previous recessions, or economic slowdowns, U.S. Treasuries were the biggest beneficiaries of that rise in fear," Mr. Denis said.

The Bloomberg Barclays U.S. Long-Government Bond index had a 20.9% return for the quarter and 32.64% for the year ended March 31; the Bloomberg Barclays U.S. Aggregate Bond index had a quarterly return of 3.15% and a one-year return of 8.93%; the Bloomberg Barclays Global Aggregate ex-U.S. Bond index returned -0.33% for the quarter ended March 31 and 4.2% for the year; and the Bloomberg Barclays U.S. Long-Duration Corporate Bond index ended the quarter with a -4.51% return but a 9.57% return for the one-year period.

Mr. Denis said market pressure began to abate in late March following the Federal Open Market Committee's two unprecedented cuts to the federal funds rate, the Federal Reserve decision to expand its balance sheet to buy investment-grade credit and agency mortgages, and an economic stimulus bill passed by the U.S. Senate.

"With the Federal Reserve announcing they were going to do whatever was necessary to keep markets afloat and the addition of a U.S. stimulus bill, we saw a little bit of a recovery that continued into April," Mr. Denis said.

President Donald Trump signed the $2.2 trillion Coronavirus Aid, Relief, and Economic Security Act into law on March 27.

For the year ended March 31, the median return for long-duration domestic strategies in Morningstar's universe was 14.17% and the median return for Morningstar's entire domestic fixed-income universe was 4.21%.

Aegon USA Investment Management LLC's Long U.S. Treasury STRIPS strategy topped Morningstar's list of top performers for the year ended March 31, posting a gross return of 47.68%.

"This is part of our government strategy, which is really trying to help benefit plans maximize some of those very long-duration liabilities but at the same time allowing them to free up some capital to allocate to other parts of the market. That has certainly proven to be beneficial over the last year or so as interest rates have fallen fairly dramatically," said Calvin Norris, the Cedar Rapids, Iowa-based U.S. rates strategist and portfolio manager for the strategy.

Mr. Norris said the portfolio closely tracks the Bloomberg Barclays 20+ STRIPS index but it is an active strategy. The portfolio has very low turnover, he said, as portfolio managers minimize trading expense within the fund. "Generally speaking, because of the high cost of trading STRIPS we tend not to make a lot of significant relative-value bets on a short-term basis. Most of our relative-value positioning within the portfolio tends to be more long term in nature. We tend to keep the duration and curve profile very similar to the benchmark, not taking active duration bets as frequently as we might in other, more liquid strategies," Mr. Norris said.

NISA Investment Advisors LLC's 15+ STRIPS fixed-income composite remained in second place on both the one- and five-year lists for the second consecutive quarter, with a gross one-year return of 45.63% and a gross annualized 9.48% return for the five years ended March 31.

"Many of our clients are defined benefit plans and they have chosen to utilize part of their assets to hedge the interest-rate sensitivity that is embedded in their liabilities. One way to do that is with an allocation to long-dated Treasuries, specifically STRIPS, so many of our clients have engaged us to buy long STRIPS on their behalf," said Joe Murphy, director, portfolio management at NISA Investment Advisors in St. Louis.

Mr. Murphy said falling interest rates have been the primary driver behind the strategy's returns for both the one- and five-year periods.

"If we look at long-term interest rates over that five-year period, they're sharply lower. From March of 2015 to March of 2020, long-term interest rates were approximately 120 basis points lower. Given the long-duration of the STRIPS allocation, with 120 basis points lower yield, you're going to have positive returns," he said.

The Federal Open Market Committee responded to economic concerns related to COVID-19 by lowering the target range for the federal funds rate to zero to 0.25% at an unscheduled meeting on March 15, from the 1% to 1.25% range it set March 3.

"The credit goes to our clients for choosing an allocation to STRIPS, which have performed exceptionally well as long-term interest rates have fallen," Mr. Murphy said.

Hoisington Investment Management Co.'s macroeconomic fixed-income composite was in third place on the one-year list, returning a gross 40.19% for the 12 months ended March 31.

Two strategies from Pacific Investment Management Co. LLC rounded out the top five for the year ended March 31. PIMCO's Long-Duration Treasury strategy was in fourth place with a gross 31.72%. PIMCO's Long Bond Extended Duration strategy returned 30.22%, which put it in fifth place for the year, while a gross annualized 8.57% return placed it fourth for the five-year period.

New York-based 16th Amendment Advisors LLC's Vicksburg strategy led the list of five-year returns with a gross annualized 28.2%.

"Vicksburg is a fixed-income strategy focused on high-grade municipal bonds. The fund buys taxable and tax-exempt municipal bonds without limitations on maturity or duration, state, coupon or structure," said John J. Lee, managing member, in an email. "The fund generally uses margin leverage and hedges interest-rate exposure. From time to time, the fund will buy corporate bonds. It favors bonds that are highly liquid or are deemed essential service."

Strategic Income Management LLC's SiM High Yield Institutional strategy was in third place for the five years ended March 31, with a 9.14% return. Camden Asset Management LP's Long Duration Government Credit composite completed the five-year list with a gross annualized 8.43% return.

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 March 31, with a net 51.23% and a net annualized 9.69%, respectively.

T. Rowe Price Group Inc.'s U.S. Treasury Long-Term Index trust ranked second on the one-year list, with a net 34.39%. BlackRock Inc.'s 20+ Treasury Bond Fund was in third place for the year, with a net 33.47%. BlackRock's CIT strategy was in second place on the five-year list with a net annualized 7.55%.

Northern Trust Asset Management's Long-Term Government Bond Index Fund-Lending took fourth place, with a gross one-year return of 33.36% for the year, and third on the five-year list, with a gross annualized 7.54%.

Northern Trust's Long-Term Government Bond Index DC Non-Lending Fund rounded out the top five of the one-year list with gross return of 33.24% and placed fourth for the five-year period with an annualized 7.48%.

State Street Global Advisors' U.S. Long Treasury Index Non-Lending Class A fund was in fifth place on the five-year list with a gross annualized 7.39%.

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 May 7.