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Q: What is the history of the fund?
The fund began over 15 years ago with the goal of providing a reliable and diversified return stream within the taxable bond space. It sits in the broadest of fixed-income categories which is the intermediate or core/core-plus space of the market, and is benchmarked to the Barclays U.S. Aggregate Bond Fund.
A real differentiator is our team approach. We draw on input from a 100+ member fixed-income team which gives us an array of security selection. Having this information, along with the ability to be dynamic as these inputs change over time, helps the fund have a reliable outcome and better risk-adjusted returns.
Assets under management are currently $2.9 billion in the intermediate bond fund, and in the core-plus strategy they are $10 billion.
Q: Would you describe your investment philosophy?
We believe intensive research, both top-down and bottom-up, is critical. Having dynamic feedback loops and constantly challenging what we are seeing leads us to an understanding of the global macro environment in its entirety. Our research process shows where top-down or bottom-up factors either line up or do not, and builds conviction in our view. Through it, we can evaluate different upsides versus downsides, as well as opportunities and risks, and allocate more to investments that have better symmetry.
This approach is embedded within asset teams. Macroeconomic teams—whether in rates, currencies, or emerging markets—drive the top-down component, and sector teams—including investment-grade credit, high yield corporates, securitized, and mortgages—provide bottom-up research.
The best investment culture is one where these two teams communicate as often as possible and question each other to develop a global macro view.
Q: What is your investment strategy and process?
A strategy team comprised of senior leaders overseeing each sector of the bond market informs our global macro view and ultimately portfolio allocation. They are involved in dialog that occurs daily, weekly, monthly, quarterly, and semi-annually. Portfolio managers for the intermediate bond fund set asset allocation and a risk allocation budget based on insight continuously coming through these leaders.
Once the global macro view is established, portfolio managers allocate a percentage of the fund’s dollars to each sector team, who buy and sell securities. Asset teams are given duration targets, ratings targets, and any other unique risk characteristics we decide to target for a sector. Investment-grade credit, for example, may target a certain number of financials versus energy names, or limit those in the portfolio. This is meant to put us in the right sectors, put the right amounts in each, and then go forward and buy securities with the best upside/downside.
Our process encourages sharing information because investing is ultimately a team sport. It is biased toward good team leaders and communicators rather than people who may be extremely smart but better at working within individual silos. We value people who actively create dialog both upward into the organization and laterally throughout it.
Though we have individual teams for emerging market debt, high-yield corporate debt, and investment-grade corporate debt, we cultivate conversations across them to inform a better house view on factors that will impact all three, like oil prices, supply/demand imbalances, and regulatory changes. For example, our energy analysts communicate with the teams about falling oil and gas prices and their exposures to drillers, independent energy, and midstream companies.
Our investment process also involves risk management oversight to ensure that as all securities are bought and sold, risk budgets are adhered to. It provides a detailed awareness of all risk metrics including tracking error, duration, and yield curve position.
Q: What is your research process and how do you look for opportunities?
Each asset team has its own research, which we believe is better than a standalone model. Quantitative research acts as an umbrella and helps the fundamental analysts embedded in the investment teams by providing forecasts and using big data. To make sure we get synergies, the teams coordinate and communicate with each other as much as possible.
So what does that mean? As an example, within commercial mortgaged-backed securities (CMBS), our portfolio managers and analysts have an expert understanding of that space as well as buying and selling bonds. Our quantitative tools will look across all available data in the U.S. for commercial property prices by region and by property type—office, retail, hotels, apartments, and industrial properties—to pull in as much macro data as possible to inform the teams and our bottom-up research analysts about trends we see in the different markets.
These trends may work as an early warning sign for potential downside risks in any deals, apprising all the analysts who cover different sectors of the bond market. During the rebound that followed the financial crisis, CMBS was really a primary market story, and our quantitative tools and the application of big data helped us understand this environment from the top-down and see trends like the divide between primary markets and tertiary markets.
The next step of our research process is qualitative and fundamental assessment. Analysts attend industry conferences, dial in for management conference calls, and analyze fundamental information about an industry and the companies within it. They develop an internal view of the creditworthiness of each issuer and generate an opinion about which issuers should go in the portfolio, and whether it should be overweight/underweight.
Staying within the CMBS example, this step of the research process evaluates each individual trust, what properties are in it, and the property values available within each securitization. We spend a lot of time looking at deals that have been in the market for multiple years; this allows us to buy securities with a much more informed view of their maturity type, average life, or prepayment.
After assessing securities, we try to buy those with a better risk-return profile than the market anticipates, sell those identified as having more downside risk, and always look for those with better symmetry. When two bonds have the same upside, it is then necessary to analyze their downsides and choose the one with the better upside/downside ratio. Many investors miss this and think the game is more about being long risk or short risk. Our position is that better symmetry of risk drives better returns.
Q: Can you share another example?
Another example that illustrates our research process is how the fund is positioned in the energy space. Since Thanksgiving 2014, when Saudi Arabia said it would not cut production to defend energy prices, there has been a freefall in the price of oil. We needed to take a thorough underwriting of the portfolio’s energy exposure and ultimately decreased it by getting out of those names—particularly high-yield companies that either did not have hedges on or had hedges on that were not substantial enough to live below a $50-energy price for an extended period.
Understanding the macro environment and having an opinion on where oil prices could go then provided the context for individual subject-matter experts to opine on which companies could survive this downturn in energy and which could not.
This also pointed us in the direction of more midstream assets. In looking for the best risk-return balance within the sector, we leaned away from drillers and toward midstream assets like the pipes needed to move the energy within and out of wells that had already been drilled.
In a nutshell, in our research process analysts maintain ratings and recommend names. Through a partnership with the portfolio managers, sector portfolio managers decide which names get in. When our investment thesis has either been proven right as played out, or is proven wrong, we exit. Once there is no longer a belief in the reason a name got in that means it should be sold to contain downside risk.
Q: How do you construct the portfolio?
The portfolio construction process starts with a detailed risk budget and an allocation to the major sectors of the bond market. This portfolio focuses on taxable bond markets, so the sectors it invests in are Treasury bonds, agency bonds, and agency mortgages; within the securitized realm are commercial mortgaged-backed securities, non-agency mortgages, and other asset-backed securities like autos. Within the corporate realm, we buy investment-grade corporate bonds as well as high-yield.
Overall, 80% of the bonds in this fund must be investment grade or above at all times, so there is a limit to the extent we can use low investment-grade rated bonds.
Although a good portion of emerging-market debt is below investment grade and we are capped by the 20% cumulative limit across all sectors, we deploy some emerging market in the portfolio. Opportunistically we also buy foreign sovereign debt from developed-market sovereigns.
The fund’s benchmark is the Barclays Aggregate Bond Fund, which is the broadest measure used for most taxable bond funds. Our goal is to beat the benchmark on average by 150 basis points a year over a cycle, and we do so with a diversified portfolio that owns multiple hundreds or a thousand CUSIPS at any give time. The maximum position of a holding is 5% per SEC limits, but the vast majority are less than 1%.
Turnover is quite high—in the 400% to 500% range—as we dial up or down individual sectors and names where we see value for a given risk budget. However, the vast majority of the portfolio turnover is tied to mortgage securities which are very liquid. We re-optimize these frequently, so the turnover across other asset types, like corporates and securitized commercial mortgaged-backed securities, is quite lower, and is under 100% of the fund’s overall turnover.
Once risk allocations are set, a detailed error and risk budgeting process makes sure we remain within risk bounds at all times. So when determining asset allocation, we are aware of the tracking error target and the tracking error coming from the portfolio’s individual components. Risk allocation is made with the knowledge of what the risk statistics are likely to be; ultimately, the aim is to understand what risks we want, understand the correlations of those risks, and understand how those risks will help achieve the fund’s end goal.
The role of portfolio management is to coordinate individual sector teams in deploying risk budgets and to make sure, as they buy and sell unique securities; it all comes together in a cohesive package. The majority of our value-add and alpha comes from being the right amount of each sector and the right securities.
We do not take large duration views and manage duration every day at the overall portfolio level. Typically, duration will be within half a year of the benchmark’s overall duration measure, so it is a very small part of the overall risk budget relatively.
Q: How do you define and manage risk?
We believe we have a world-class risk function. It is a part of our process from stem to stern, and we have invested heavily in it.
A core belief is every risk model and metric we use is inherently flawed and incomplete, so we utilize all the measurement tools possible, then step back and see what they are telling us in a more collective sense. For example, using just tracking error is inherently limited by the data set available to feed into that volatility matrix. It is also limited by the correlations assumed by the tracking error model.
Having the reporting lines of an independent risk team is critical. That team is also embedded alongside the asset managers and has no informational asymmetry; they see the same information and have a shared understanding of our strategies and what we are trying to accomplish in the portfolio. Its role is not to just administer compliance—that is the compliance team’s job. Instead, the risk team helps us understand broader risks to the portfolio.
To understand these broader risks, we evaluate many things: market value exposure to the fund and its nominal percentage, how much duration and spread are in different sectors, how sensitive the ratings are, and our rating skew within each sector. Ultimately, we want to deploy just enough risk to achieve the fund’s goals to generate excess return to market return.
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The history of the fund actually starts before it was established. The team came together at the end of 2003. Using the same strategy we employ today, we primarily managed institutional international and global equity portfolios.
The history of the fund actually starts before it was established. The team came together at the end of 2003. Using the same strategy we employ today, we primarily managed institutional international and global equity portfolios.