Long-duration strategies dominate top 10 list for fixed income

Long-duration bond strategies took over the list of top-performing fixed-income strategies for the year ended June 30, filling all of the top 10 spots, according to Morningstar Inc.'s separate account/collective investment trust database.

In the previous "risk-on" quarter, high-yield strategies occupied five of the top spots, but Gabriel Denis, associate analyst, fixed-income strategies, at Morningstar in Chicago, said expectations of a potential rate cut boosted longer duration strategies in the second quarter.

"The things that we saw doing best were the ones that had longer duration exposure because that was what benefited from expectations that the Fed would soon cut rates. U.S. Treasuries did well, especially ones on the longer end of the Treasury curve. Corporates, in general, did well. We actually saw investment-grade corporates do slightly better than high-yield corporates and that can generally be attributed to the fact that most of those investment-grade corporates tend to have greater interest rate sensitivity," Mr. Denis said.

The Federal Open Market Committee left the federal funds rate unchanged at 2.25% to 2.5% at its May meeting, but issued guidance suggesting upcoming rate cuts. "Again, expectations around a rate cut generally helped longer-duration securities," Mr. Denis said.

"It wasn't quite that same hyper rally that we saw in the first quarter, but it was still a fairly strong quarter for most asset classes that we examine in fixed income. The laggard of this quarter was, generally, securitized products, especially asset-backed and agency mortgage-backed securities, which were less attractive than U.S. Treasuries on a relative basis, particularly given that they had much shorter durations," Mr. Denis said.

For the year ended June 30, the median return for long-duration domestic strategies in Morningstar's universe was 14.15%, the median return for domestic high-yield fixed income was 7.35%, and the median for Morningstar's entire domestic fixed-income universe was 6.95%.

The Bloomberg Barclays U.S. Long-Duration Government/Credit index returned 13.82% for the 12 months ended June 30, the Bloomberg Barclays U.S. Aggregate Bond index returned 7.87% and the Bloomberg Barclays U.S. Corporate High-Yield index returned 7.48% for the year.

Conning's LDI Credit Over 25 Year Maturity debuted on Morningstar's one-year ranking in first place with a gross return of 16.32%.

"It's (a liability-driven investment) strategy so, ultimately, the objective is focused around the institutional pension plan community and the liabilities that they're managing against. A lot of those liabilities are long-duration in nature, so this strategy is one that we use to provide a way for institutional pension plans, both large and small, to get credit exposure or spread exposure. If you just bought long-duration Treasuries, you would get the rate exposure but not the spread component, so we created this strategy to give you both," said Sean Kurian, the New York-based managing director and head of institutional solutions at Conning.

Looking at performance for the 12 months ended June 30, Mr. Kurian said, "It's really a story around where rates have been. Rate levels at the long end of the market are probably the main driver for stronger returns. The account does invest in credit assets, and the slight overweight to corporates may have helped. In terms of industry sectors within corporates, we've avoided sectors that more recently haven't done as well, for example, energy."

He said a long-duration bias and matching an LDI strategy to a plan's liability profile is not enough for institutional investors, so active credit selection and bottom-up research in the credit markets allow the portfolio to offer additional sources of alpha.

"If you think the long-duration space is kind of staid and vanilla, this strategy is a bit more customized than what you would usually find. Pension plans are strategic investors, given their LDI focus and what they're trying to achieve in the long term, and this strategy is designed to provide that long-duration exposure with the spread so it's not just about rates," Mr. Kurian said.

Columbia Threadneedle Investments' Long Duration Investment Grade Corporate Fixed Income portfolio gained second place on the list, returning a gross 16.13% for the year ended June 30.

Timothy Doubek, senior portfolio manager, investment-grade credit, at Columbia Threadneedle in Minneapolis, said "Our long-duration strategy is managed against the long component of the Bloomberg Barclays corporate index. And we do a very research intensive, very bottom-up credit analysis, adding value through overweighting and underweighting the right issuers and picking the right place on the credit curve, depending on what relative value is."

The strategy uses futures to manage interest-rate risk within the portfolio. "We want to have a risk-neutral portfolio so risk, generally, is the same as the benchmark. Key rate duration, the overall interest-rate risk, we want to have that as close to the benchmark as possible so that when we make good decisions on overweighting and underweighting issuers, or decisions on the credit curve, whether it's underweighting 20-year bonds and overweighting 30-year bonds, we want that to be a pure source of alpha for us," he said.

The investment-grade strategy is focused on the BBB market and credit selection is made with one- to three-year year views on companies, with low issuer turnover, Mr. Doubek said.

"There are a lot of levers to pull within BBB. There's a lot of spread volatility and a lot of issuer comparisons where we can say this high-BBB energy vs. this low-BBB energy being 50 basis points apart is way too wide. When you look at utilities, pipeline, energy, communications, a lot of industrial sectors, the fun is in BBB. That's where you can leverage the research skill and generate alpha," he said.

For the year ended June 30, Mr. Doubek said, "When I look at our relative performance attribution over this period, for example, issuer and bond selection has driven 85% of the alpha. The issuers we invested in outperformed their benchmark peers, particularly within communications and consumer non-cyclicals, including food and beverage, health care and pharmaceuticals. This alpha generation comes from our credit research focus and understanding of how to pick the right point on the credit curve."

Rounding out the top five, Pacific Investment Management Co. LLC's Long-Term Bond - Long Credit strategy was third, returning a gross 15.94%; the Long Corporate strategy of Standish Mellon Asset Management Co. LLC returned 15.83%; and Agincourt Capital Management LLC's Long Duration Credit strategy was in fifth place for the period, with a gross return of 15.65%.

Miami Beach, Fla.-based Thomas J. Herzfeld Advisors Inc.'s Fixed income Composite topped the list for the five-year period, with a gross annualized return of 8.58%. All multiyear returns are annualized.

Herzfeld's strategy has led the list of five-year returns for four consecutive quarters.

The strategy is in Morningstar's high-yield bond category and Erik Herzfeld, president and portfolio manager, said lower-rated securities, particularly leveraged loans, performed well during the first quarter of 2019, but managers began to reduce risk, limit credit exposure and lower the portfolio's duration during the second quarter.

"We've stuck to our positioning and only in this past second quarter did we start to trim our leveraged loans and reduce those because we felt, with the Fed going into easing mode, even though that would be very good for our holdings, we felt it made sense to reassess our credit quality. We began to sell our lower-rated holdings and replace those with higher-rated securities," Mr. Herzfeld said.

The fixed-income composite's average credit quality is currently investment grade, in the BBB- range, he said.

"The Fed was on autopilot and (Chairman Jerome) Powell was indicating he would continue to hike, and it seemed that was what they were going to do. Now, they're in an easing cycle and it seems like it might continue. At the end of the day, we don't know. The only thing we do know is that there's going to be a lot of volatility, which we've started to see, so we're trying to keep our risk more in a trading mentality rather than a long-term view," he said.

Although leveraged loans were an important component in the portfolio for the period through June 30, Mr. Herzfeld said credit "comes in many shapes and forms," and diversification is key to the strategy's risk management approach.

"We take deep dives in credit land. We're looking for value where most people don't look, looking for idiosyncratic positive alpha generators, lots of different individual holdings that in unison can simultaneously outperform," he said.

The median return for long-duration bond strategies in Morningstar's universe was an annualized 5.97% for the five years ended June 30, domestic high-yield strategies returned 4.46%, and the entire Morningstar domestic fixed-income universe returned a median 3.19% for the five-year period.

The Bloomberg Barclays U.S. Long-Duration Government/Credit index returned an annualized 5.68% for the five-year period, the Bloomberg Barclays' U.S. Corporate High-Yield index returned 4.7%, and the Bloomberg Barclays U.S. Aggregate Bond index returned an annualized 2.95% for the five years ended June 30.

NISA Investment Advisors LLC's 15+ STRIPS fixed-income composite was in second place on the five-year list, with a gross annualized return of 7.83%; PIMCO's Long-Term Bond - Long Credit strategy was third, with 7.14%; the High Income strategy from Artisan Partners returned 7.1% for the five-year period, putting it in fourth place; and Camden Asset Management LP's Long Duration Government/Credit Composite was in fifth place, with a gross annualized 7.09% for the five years ended June 30.

Wellington Management Co. LLP's CIF II U.S. Investment Grade Corporate Long Bond topped Morningstar's domestic collective investment trust universe for the year ended June 30, with a net 16.11%, and the strategy was in second place for the five-year period with a net annualized 6.21%. Wellington's CIF II Long Bond strategy was also on the five-year CIT list, in fourth place with a net annualized 6.07% return.

Northern Trust Asset Management's Long Term U.S. Corporate Bond Index Fund - Non-Lending was in second place for the year ended June 30, with a net 15.2% return, while Northern Trust's Long Term Credit Bond Index Fund - Lending's 15% return and Long-Term Credit Bond Index Fund - Non-Lending's 14.95% return put the strategies in fourth and fifth place, respectively.

BlackRock Inc.'s Long Corporate Bond Index fund rounds out the top five CITs for the one-year period, in third place with a net return of 15.03%; while BlackRock's 20+ Treasury Bond Fund was in third place on the five-year list with a net annualized 6.07%.

DDJ Capital Management LLC's Total Return Credit I Composite was first on the list of CITs for the five-year period through June 30, returning a net annualized 6.69%; and State Street Global Advisors' U.S. Long Credit Bond Index strategy completes the five-year list, in fifth place with an annualized 5.95% net return.

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. 2.