Weathering the storm

Portfolio managers who battened down their hatches for credit market squalls, falling U.S. rates and a sagging greenback led the ranks of fixed-income performers for the 12-month period through June 30, according to Morningstar Inc.'s separate-account/commingled-fund database. Managers of long-government- and multisector-bond strategies dominated the winner's circle. But none of the high-yield managers who sported the best returns for the five-year period through June managed to break into the one-year top 10. The median return for U.S. bond managers for the one-year period through June was 5.8%. Over the same period, the Lehman Brothers Aggregate Bond Index posted a 7.12% rise, the Lehman Brothers Long Government/Credit Bond Index climbed 6.78%, and the Merrill Lynch U.S. High Yield Master II Index dropped 2.11%. Leading the pack for the 12-month period was Los Angeles-based TCW Group Inc.'s strategic- mortgage-backed-securities strategy, with a 23.3% return — 7 percentage points ahead of the next-strongest competitor. Jeffrey Gundlach, chief investment officer and chairman of TCW's multistrategy fixed-income committee, isn't shy about pointing out that he and his colleagues saw the credit crunch coming early on. On June 27, 2007, almost the precise starting point for the latest 12-month rankings, Mr. Gundlach — in a keynote speech at Chicago-based Morningstar's annual investors' conference — predicted that the market was facing an "unmitigated disaster" because of subprime mortgages. TCW's strategic-MBS portfolio was positioned accordingly, with zero credit risk in agency-guaranteed mortgages best positioned to benefit should the U.S. central bank lower interest rates, as the firm anticipated, he said. "This is what it's all about. People talk about risk management as being fundamental" to their processes, but only "when the rubber meets the road" does it become apparent who is adept at managing risk, Mr. Gundlach said. Other firms that pride themselves on risk management, such as New York-based BlackRock Inc., have a lot of explaining to do, he said. That a strategy focused on a market segment experiencing unprecedented turmoil could top the bond strategy rankings is a testament to TCW's risk management prowess, said Mr. Gundlach, who called the latest 12-month period "our finest hour."

DRAMATIC CHANGE

Portfolio holdings have changed dramatically over the year, in line with the market's pummeling. Today, the strategic-MBS portfolio holds a "significant amount" — 40% — of non-guaranteed mortgages, reflecting the sharp drop in valuations there, Mr. Gundlach said. Columbia, Ind.-based Reams Asset Management Co.'s real-return-fixed-income strategy boasted the second-highest one-year return, 16.1%. Officials at Reams didn't return calls seeking comment. In third place was Newport Beach, Calif.-based Pacific Investment Management Co.'s real-return-full-authority strategy, which delivered a 15.5% return for the year. Robert Greer, executive vice president and real-return product manager, said Pimco's Treasury- inflation-protected-securities-focused portfolio enjoyed "the opposite of a perfect storm" over the past year, as the credit crunch sparked a flight to quality that benefited Treasuries and concerns about inflation helped TIPS in particular. Pimco used its "full authority" to good effect, avoiding segments hurt by the credit crisis and taking positions in others, such as emerging-markets debt, which paid off, while spreading risk in such a way as to minimize tracking error, he said. For the coming year, it is unlikely that falling rates and rising energy prices will be as supportive for TIPS as they were over the past year, and Pimco's real-return managers are finding some attractive risk-reward trade-offs now at the top of the corporate-credit capital structure, Mr. Greer said. In fourth place with 15.1% was Boston-based PanAgora Asset Management Inc.'s multisector-fixed-income-long-short strategy. Patrick O. Bresnehan, PanAgora's director of macro strategies, said the success of the portfolio's quantitative models in catching an inflection point between the first and second quarters helped deliver strong absolute returns. The strategy, which strives to approximate zero duration while positioning itself to anticipate yield curve movements, was long on the two-year end of the market at the start of the year and short the 10-year side, anticipating that the spread between the two of slightly less than 1 percentage point was too low. That bet worked well, as the spread doubled to about 2 percentage points by the end of the first quarter. In the second quarter, market psychology began focusing more on inflationary pressures, and PanAgora's model, which re-balances at the start of each month, caught that inflection point in fairly timely fashion, shorting the two-year end of the portfolio while going long the 10-year, as the spread narrowed to about 1.4 percentage points, Mr. Bresnehan said. Despite that spike in inflationary caution, both he and Mr. Gundlach said they strongly believe that the Federal Reserve won't boost rates anytime soon. To do so with the economy in such a fragile state would put Fed policymakers at risk of joining their counterparts of the 1930s in making disastrous policy mistakes, Mr. Gundlach said. Boston-based Baring Asset Management Inc.'s global-fixed-income strategy posted the fifth-strongest return for the year of 15.06%, helped by the dollar's continued softness in currency markets. Alan Wilde, Baring's London-based head of fixed income and currency, said that once again, "the weakness of the dollar contributed to very high returns" for the U.S.-dollar-benchmarked strategy at a time when bond markets haven't been generating great returns on their own. The Baring strategy's long positions in currencies such as the Singapore dollar and the Mexican peso have "worked very well," but Mr. Wilde said that the internal debate now is whether the U.S. dollar's long slide is just about played out. During the second quarter, the firm "reduced [its] dollar underweight exposure by [4 percentage points]," from 33% of a global portfolio that calls for 40% exposure to 37%, he said. While the U.S. economy's woes have been center stage over the past year, "if the market continues to dislocate, the chances of getting negative surprises from the rest of the world ... could push the dollar higher," said Mr. Wilde, who predicted that the Baring portfolio will take on greater dollar exposure during the current quarter "and build up quite an aggressive long [position] in dollars by the end of the year." Of course, there is still room for negative surprises in the United States, such as the housing market, which could reverse that trend, he noted. Five more long-term-bond and long-government strategies filled out the top 10, led by New York-based Jennison Associates LLC's active-long-fixed-income strategy at 14.8%. It was followed by Austin, Texas-based Hoisington Investment Management Co.'s macroeconomic fixed-income strategy at 14.2%, Jennison's active-long-government strategy at 13.8%, Pimco's Long-Term Bond Long Government/Credit strategy at 13.4%, and St. Louis-based NISA Investment Advisors LLC's long-duration-consolidated strategy at 13.2%. Rankings for the five-year period through June 30 were dominated by high-yield managers, led by Toronto-based Guardian Capital Advisors LP's high-yield strategy at an annualized 11.6%, Cherry Hill, N.J.-based Penn Capital Management Co.'s high-yield-fixed-income strategy at 10.7%, Miami-based Thomas J. Herzfeld Advisors Inc.'s taxable-closed-end-bond strategy at 10%, Los Angeles-based Post Advisory Group LLC's high-yield-plus strategy at 9.8% and New York-based DCM Partners LLC's high-yield strategy at 9.6%. For the five-year period through June, the median return was an annualized 3.9%, while the Merrill Lynch high-yield index posted an annualized gain of 6.9%. Topping the limited-duration category for the year was San Diego-based Credit Suisse Asset Management LLC, with an 8.9% return, while for the five-year period through June, Chicago-based Lotsoff Capital Management's enhanced-cash-ultrashort-bond strategy delivered an annualized return of 5.9%. At the top of the intermediate-duration-bond rankings for the year was Newark, N.J.-based Prudential Retirement's core plus strategy, subadvised by Pimco, with an 11.4% return, while for the five years, Pimco's all-asset strategy led the way with an annualized 8.5%. In high yield, the best-performing manager for the year was Upper Saddle River, N.J.-based Seix Investment Advisors LLC, whose high-yield-plus strategy delivered a 5.4% return. London-based Ashmore Investment Management Ltd. delivered the strongest emerging-markets-debt returns for both the one-year and five-year periods, with the firm's local-currency-debt portfolio posting a 19.5% gain for the 12-month period and its Asian recovery fund garnering an annualized 20.2% a year for the past five years. Douglas Appell is a reporter at sister publication Pensions & Investments.