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4 Investment Strategies Now on Our Radar

Strong fund managers and processes drive these additions to the Morningstar Prospects list.

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Morningstar Prospects, a list of up-and-coming or under-the-radar investment strategies that Morningstar Manager Research thinks might be worthy of eventual full coverage, added four new strategies in the second half of 2020.

Here's a look at the strategies that the team added to the January 2021 list and what each has to offer.

Hartford Small Company (IHSAX)
Hartford Small Company has undergone several changes during its lifetime but has found some stability under lead fund manager Steve Angeli, whose time on the strategy dates to January 2000, when the fund was still in its previous multimanager structure. He has support from comanagers John Schneider and Ranjit Ramachandran, who came aboard in March 2018 and February 2020, respectively. The fund has been in its current form since August 2018, when Mammen Chally was removed as portfolio manager. From that time, the team has plied an effective approach rooted in deep due diligence, fundamental analysis, and valuation analysis. The team prefers companies with sustainable revenue growth, improving profitability, leading or improving market share in their addressable markets, and healthy balance sheets. While not every company will match each criterion, the team selects the top growth stocks from its investable universe (those within the market-cap range of the Russell 2000 and S&P SmallCap 600 indexes). While still a short time, this measured approach has rewarded investors. The investment strategy trounced its Russell 2000 Growth Index and median small-growth Morningstar Category peer since taking its current form through October 2020. The team's strong stock-picking across multiple sectors and industries has offered compelling results in both up and down markets.

iShares ESG Advanced High Yield Corporate Bond ETF (HYXF)
IShares ESG Advanced High Yield Corporate Bond ETF attempts to balance the incorporation of environmental, social, and governance factors with representing the opportunity set available to investors in the high-yield bond market. That said, its ESG criteria lead it to omit bonds from issuers in the energy and power-generation sectors, which represent roughly 15% of the portfolio of its non-ESG cousin, iShares iBoxx $ High Yield Corporate Bond ETF (HYG). The net result is a portfolio that takes slightly less credit risk and a touch more interest-rate risk than the junk-bond market at large. The exchange-traded fund has a solid chance at besting category peers on a risk-adjusted basis over a full market cycle, thanks to its broadly diversified and slightly more conservative portfolio. Also, its low 0.35% annual fee gives it an edge relative to pricier actively managed peers.

The fund tracks the Bloomberg Barclays MSCI US High Yield Choice ESG Screened Index, which begins with the Bloomberg Barclays US Corporate High Yield Index. The fund removes bonds from issuers that derive a significant amount of revenue from a litany of controversial sectors, including fossil fuels, gambling, for-profit prisons, and alcohol. It also removes issuers with low ESG scores relative to their sector peers. MSCI assigns these scores based on ESG risks and opportunities in each industry that could be material to financial performance. It weights bonds that make the cut by market value, subject to a 2% issuer cap. 

The ESG exclusions remove half of the starting universe, and this introduces some persistent sector tilts. For instance, the fund avoids issuers from the energy and utilities sectors, which collectively accounted for about 10% of the average category peer's portfolio as of December 2020. Omitting these sectors served the fund well in 2020, as credit spreads widened. The pain was particularly acute in the energy sector. The fund's relatively shallow drawdown in the worst of the coronavirus crisis helped it outperform the category average by 1.2 percentage points for the year. That said, it lagged as markets rebounded from their March lows--evidence that this fund's relatively conservative credit profile can cut both ways.

Payden Absolute Return Bond (PYARX)
Fixed-income specialist Payden & Rygel launched the American vehicle of this absolute return strategy in late 2014, two years after the debut of the Australian portfolio, which Morningstar has rated since 2016. Despite a recent fund manager departure, few can match the tenure of its leadership team. Manager Brad Boyd departed in August 2019, and the firm responded by adding four experienced fund managers. Key decision-makers Brian Matthews and Scott Weiner remain. A well-regarded and stable sector group supports the six seasoned managers. Payden Absolute Return Bond applies the same top-down portfolio-building approach that earns an Above Average Process rating from Morningstar Australia. The long-term macroeconomic outlook of the firm's investment committee sets the basis for analysts and traders across sector teams who seek securities that can provide a steady source of income.

Overall, the combination of seasoned fund managers and a thoughtful approach tested through various environments makes Payden Absolute Return Bond an investment strategy to keep an eye on.

Western Asset Macro Opportunities (LAOIX)
Western Asset Macro Opportunities' experienced and complementary comanagers, skillful execution of its flexible mandate, and deep specialized fixed-income research teams make it an interesting nontraditional bond proposition. Fees need to come down a bit, though. This high-conviction approach is led by Western Asset's CIO Kenneth Leech, who has over four decades of industry experience and comanages Gold-rated funds Western Asset Core Bond (WATFX) and Western Asset Core Plus Bond (WACPX). Prashant Chandran, head of derivatives, backs Leech, with whom he has worked since 2007. They also make good use of the firm's strong and experienced global sector teams for ideas.

This investment strategy is one of the more flexible offerings within its nontraditional bond category. It can take long and short positions across global credit, rates, and currency markets; has a wide duration range of negative five to 10 years; and makes liberal use of derivatives.

The fund has trounced the competition since its August 2013 inception, with nearly all the underlying strategies contributing to returns.

To learn more about the latest changes to the Morningstar Prospects list, sign up for our webinar.

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Nicholas Goralka does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.