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Q: Would you tell us about the history of the fund?
The fund dates back to 1971, when Morgan Stanley Asset Management ran fixed-income mutual funds for Van Kampen. We took over management of those portfolios when Invesco acquired Van Kampen in 2010, and currently have more than 160 investment professionals dedicated to fixed-income. The fund has $1 billion in assets under management
The portfolio includes investment grade, high yield, and emerging markets; all corporate bonds and government-related securities, predominantly from the U.S. government. Although it allows investing in foreign government bonds, they are a very small portion. Historically, the fund has no exposure to bank loans or floating-rate loans.
Over the last five years, the biggest evolution in the portfolio is its marginal increase in the use of high yield, which can go up to 20%; today it is 15%. Prior to that, average allocation was 5% to 7%. We monitor and modulate this position as appropriate.
Q: What is your investment philosophy?
First, we feel our macro research, sector themes, and bottom-up credit research will help the fund outperform peers and its benchmark regardless of the credit environment.
Because the fixed-income market is enormously complex and broad, research is critical to our process—it helps identify names that can outperform and also steers us away from potential pitfalls. So we have invested heavily in credit analysts, portfolio managers, and the technologies needed to assess and manage risk.
Whether dedicated to investment grade, to high yield, or to emerging markets, our analysts focus solely on research, cover the opportunities they think are best, and put an independent rating on every credit followed. From there, portfolio managers make investment decisions.
The culture at Invesco fosters connectivity and global collaboration. Analysts and portfolio managers across the world speak daily about what they see in their markets, work collectively to enhance the portfolio, and share the early stages of risk that might first be visible in Hong Kong or London. This back-and-forth flow of ideas, moving both upstream and down, means ideas can come from anywhere, not just research. If an idea is worth pursuing, we definitely have research staff investigate and opine on it.
Q: How do you implement your investment strategy?
The portfolio managers try to balance three inputs that include both top-down and bottom-up approaches. This process begins with macro credit input from the Investment Strategy Team, which determines whether we should be overweight or underweight in specific asset classes.
Second, we examine sector themes, which change often depending on where value in the market lies. Sector themes are developed using input from teams across every asset class, and provide multiple lenses to evaluate whether we should invest in a sector.
For example, the housing sector team includes the high-yield housing market analyst who is looking at high-yield home builders; the investment-grade Real Estate Investment Trust analyst looking at investment-grade apartment and retail REITS; the municipal bond analysts looking at local ground-up housing activity like sewage pipes; the emerging-market analyst looking at housing in Asia; and analysts from the commercial mortgage-backed securities and non-agency mortgage groups.
The third layer of input comes from credit analysts who scrub each security and generate bottom-up fundamental research to help us identify which companies to invest in.
During certain parts of the economic cycle one of these three inputs may be dominant. If the market is turning from risk-off to risk-on, the macro Investment Strategy Team approach might be the most important. In a low volatility market where everything is status quo, security selection drives returns.
Q: What is your research process and how do you look for opportunities?
We search for opportunities across the rating spectrum and can own anything from senior unsecured single A financial institutions down to BB Tier 1 capital coming out of Europe. Research is driven by our analysts and sector themes, which identify value where the market has misunderstood a particular credit and the credit agencies have underrated it.
Analysts assign a rating to each bond considered for purchase. If the agencies rate a high-yield name a BB but we think it should actually be rated investment grade, we have no problem doing that. The fund may even buy a single B rated credit that we believe should be a BB.
Last year there were two sector themes we tried to invest in: U.S. domestic and U.S. consumer. General Motors Company hit both of those and illustrates how we use credit research and connectivity with our high-yield team to be in front of the rating agencies and find value ahead of the market.
The company had traded high yield for several years and it was widely assumed GM would become investment grade, but until the upgrade actually occurred many buyers were unable to purchase it.
In June 2015 General Motors was upgraded by Fitch, after the company’s rating had already been raised by S&P. However, it did not go into the Barclays US Credit Index until the last day of the month—that is the way it works even when an upgrade occurs on the 15th or even the first of the month. So on the last day of the month there was a material amount of buying of General Motors bonds and those bonds got tighter and went higher in price.
GM had been attractive to us from both fundamental and technical standpoints. Fundamentally, the U.S. auto market was on much firmer footing. There were better vehicle models coming out of General Motors, it was getting better traction globally, and its sales were increasing. The company was paying down debt and basically paying off asset-backed securities and replacing them with unsecured debt, so its credit profile was improving.
Technically, GM is a very large bond issuer. Our view was that when the bonds were upgraded there would be a large base of buyers forced to buy General Motors on that last day of the month—indexed buyers who could not purchase it while it was high yield. We took that opportunity to adjust our positioning within the credit and moved to the next trade.
Banks were another high-level sector theme. They are well regulated and their capital ratios were continuing to improve. The government has essentially turned them into utilities, so the credit risk had gone down, almost restoring the safe-haven status banks enjoyed before the crisis.
We did not feel spread levels had fully priced this in, making the sector attractive. Within the sector we believed there would be a compression trade between senior and subordinated bonds and to the extent it could, the fund bought subordinated bonds and even some deeply subordinated Tier 1 types of credits.
Even though some U.S. banking names were rated high-yield BB or BB+, their fundamentals were so strong we did not feel as if we were buying traditional high-yield bonds. Although the rating agencies still have not upgraded these securities, we think Tier 1 preferred banks are great opportunities.
Q: How do you construct the portfolio?
The portfolio has over 500 positions. At least 65% must be investment-grade, while high yield is limited to 20%. In high-conviction, investment-grade opportunities, we take concentrated positions—typically 50 to 100 basis points, and at most, 5%—but in high yield we diversify with smaller positions because there are more unforeseen events in that space. The portfolio allows some non-dollar exposure, but it has been limited.
To create the portfolio, fund managers evaluate opportunities presented by the investment strategy team, adding sector themes and bottom-up security analysis. U.S. investment grade is a core holding, though we will also consider emerging markets and high yield. At this time, emerging markets are not very attractive, so they are underweight. However, it is important to balance input from across the globe in portfolio construction.
The fund’s benchmark is the Barclays US Credit Index, which is mainly corporate credit focused but also includes a small subset—less than 20%—of non-corporate credits.
Q: How do you define and manage risk?
The Investment Strategy Team gives top-down direction by providing a tracking error range. It is up to the fund managers to decide how to construct that risk in the portfolio. Part of this is related to the opportunity set, and part to the liquidity of those opportunities. After a thorough consideration, we sort out the risk for the portfolio and review positioning.
In addition to viewing the portfolio versus its benchmark, we also compare it to peers, focusing on spread duration, yield differential, duration times spread, notional value exposure, and tracking error. This helps determine whether there is too much or too little risk in the portfolio based upon that macro view from the Investment Strategy Team.