An Early Look at the Contenders for Morningstar Fixed-Income Fund Manager of the Year
These funds have shone in a year that's offered some surprises for bond-fund investors.
Several weeks ago, we provided an early look at several front-runners for the Morningstar Domestic-Stock Fund Manager of the Year honors. Since then, we’ve also featured candidates in the International-Stock, Alternatives, and Allocation categories. Today, we’ll tackle potential contenders in the fixed-income world.
The first 10 months of 2014 have thrown fixed-income managers a few curve balls. Many investors and portfolio managers came into the year expecting a rise in bond yields. However, the yield on the 10-year U.S. Treasury peaked at 3.04% on Dec. 31, 2013, and, despite a short sell-off in September, has marched steadily downward from there. Meanwhile, investors who had been well-rewarded for taking on gobs of credit risk saw riskier markets take a breather in the second half of the year. With a 4.0% return through Nov. 18, the Bank of America Merrill US Lynch High Yield Master II Index is still well into positive territory for the year to date but has been much less dominant than in recent years. Meanwhile, the broad Barclays U.S. Aggregate Bond Index has proved a more difficult bogy to beat this year, with the intermediate-term bond category’s average return trailing it by 40 basis points through mid-November.
To get at the list of potential contenders in 2014’s somewhat surprising fixed-income markets, we screened for funds that shone this year with at least one manager who has been around for five years or more. We homed in on funds sporting top-quartile returns over the past five years, or 10 years where applicable. All nominees must also earn Morningstar Analyst Ratings of Bronze, Silver, or Gold. We look beyond just short-term performance for funds with a proven, well-resourced management team, strong long-term performance, and solid stewardship who have also navigated 2014’s markets with skill.
A list of eight front-runners is featured below. This is not a final or exhaustive list--things can change quickly in the market’s last weeks of the year, and our deliberations may surface additional candidates--but these funds are likely to be contenders.
Given strong performance in the equity markets, many of the top performers in the various bond categories have been willing to dabble in or even hold meaningful stakes in common stock. That's true of BlackRock High Yield Bond BHYIX, which takes a somewhat eclectic approach with the flexibility to invest in bank loans and equities in addition to standard high-yield fare. The team, led by James Kennan, will also tactically hedge out high-yield risk using baskets of credit default swaps. While the fund courts significant credit risk, Keenan has built an impressive record in his nearly seven years running the portfolio. The fund has had a particularly strong 2014, as its equity stake helped drive returns; the fund also benefited from Keenan's decision to lighten up on bank loans early in the year.
Don't Chase This Fund's Performance
The second candidate is also among the high-yield bond category’s most daring entrants. With a willingness to invest heavily in the lowest-quality tiers of the junk-bond market and hold meaningful stakes in common stock, Mark Notkin of Fidelity Capital & Income (FAGIX) runs one of the most aggressive options in the group. Still, there’s more to this fund than its aggressive profile, and Notkin has shown a willingness to lighten up on risk when he grows cautious on the high-yield market's fundamentals and valuations. A move to build cash before 2008, for example, helped moderate the fund’s steep losses that year and gave Notkin plenty of dry powder to put to work at depressed valuations.
During 2014, Notkin was particularly bullish on equities relative to high yield and built the fund’s equity stake to 20%, the high end of the fund’s historic range. Strong performance from many of these names, including chip supplier Skyworks Solutions (SWKS) and several airline stocks, helped drive the fund’s topnotch performance this year. Notkin’s been particularly cautious on the lowest rungs of the high-yield market during the same period. As of September 2014, he dedicated just 10% of the portfolio to CCC rated fare, well below the index’s 15% allocation. However, while this fund has generated eye-popping returns over the long haul and benefits from Fidelity’s significant investment in research, it isn’t for the faint of heart. Indeed, looking back on an extended rally for high yield and equities, now is definitely not the time to chase the fund’s recent performance.
At the other end of the credit-risk spectrum is Fidelity GNMA (FGMNX), which focuses on high-quality government-backed mortgage securities. Comanagers Bill Irving and Franco Castagliuolo don't make big interest-rate bets here and instead focus on identifying attractively priced mortgages. The pair is backed by the usual Fidelity resources, which include proprietary analytics that allow the team to analyze the mortgage pools underlying each security. The team has quietly built a strong record, and the fund is ahead of the bulk of its intermediate-term government and Ginnie Mae-focused peers once again for the year to date through mid-November. An overweighting to prepayment-resistant mortgages, including those with relatively low remaining balances, stakes in reverse mortgages, and a modest dose of leverage have all contributed to the fund’s strong performance through the period.
Going Global ...
A mostly stable team at Legg Mason Brandywine Global Opportunities Bond (GOBAX) has managed this fund since its 2006 inception to a strong record. The team here is willing to diverge significantly from market-cap-weighted global indexes, which lean heavily toward developed markets, but instead has held large stakes in emerging-markets debt and currencies, leaving it with significant risk. Global fixed-income markets have offered plenty of potholes for the year to date against the backdrop of geopolitical turmoil and a strong dollar. However, through the first 10 months of 2014, the fund has prospered thanks to a lack of exposure to the struggling yen and euro and a sizable emerging-markets stake. The team’s decision to add to positions in Mexico, Brazil, and Indonesia as those countries suffered in 2013’s sell-off have also helped returns so far this year, as have good calls in Europe.
A Less Familiar Offering From a Well-Known Shop
Peter Palfrey and Rick Raczkowski, comanagers of Loomis Sayles Core Plus Bond (NERYX), have quietly built an enviable record in their decade-plus tenure running this fund. The fund has run a streak of top-third-ranking returns relative to its intermediate-term category in every calendar year since 2006, a period that includes 2008's credit crisis, sharp postcrisis risk rallies in 2009, and a number of zigs and zags since then. There’s definitely risk in the fund’s corporate- and at-times emerging-markets-heavy portfolios, but management has done a fine job of making adjustments to its portfolio.
The fund got good mileage out of a number of different positions during 2014. It came into the year with a duration longer than that of its Barclays U.S. Aggregate Bond Index and a preference for intermediate and longer maturities, which paid off as Treasury rates rallied in the first and second quarters. Meanwhile, exposure to European peripheral debt including Italy and Portugal and strong security selection in investment-grade credit in names including Time Warner Cable (TWC) all contributed to the fund’s performance. The fund’s credit-heavy portfolio stumbled a bit in the third quarter, and its currency exposure has hurt, but overall it is having an excellent year.
Riding the Muni Rebound
After a rough 2013 shaped by bad news out of Puerto Rico and Detroit, munis have bounced back nicely so far in 2014. Fading headline risk, combined with a Treasury rally and relatively muted supply, have all supported a rally in the muni markets through late 2014.
Against this backdrop, it’s not surprising to see Wells Fargo Advantage Municipal Bond (WMBIX) turning in a strong performance versus its long-term muni peers. Run by veteran managers Lyle Fitterer and Robert Miller, the fund takes on more credit risk than most core muni funds and tends to thrive in muni rallies. However, it had weathered 2013 relatively well thanks to its relatively short duration, a decision to trim exposure to mid- and lower-quality names coming into the year and minimal exposure to Puerto Rico. While the fund’s muted rate sensitivity hurt it in 2014 relative to its long-term muni peers, a number of other positions helped it outperform. Long-standing stakes in prepaid gas bonds and exposure to Illinois and California credits proved beneficial. The fund also got good mileage out of some Detroit water- and sewer-backed bonds that it added to early in the year at attractive valuations and has since sold.
An Impressive Turnaround
After a rocky 2008, Western Asset beefed up its investment process and risk-management procedures. Since then, the team here, led by CIO Ken Leech, has quietly reestablished topnotch records at Western Asset Core Plus Bond WACPX and Western Asset Core Bond (WATFX). While the funds’ willingness to hold positions in high-yield and nonagency mortgages can court plenty of risk, the team has carefully negotiated a variety of markets since 2008 and, notably, sidestepped trouble in a rocky 2011. The funds’ strong showings through mid-November 2014 owe largely to duration and yield-curve positioning--unlike many competitors who came into 2014 bearish on bond yields, these funds came into the year with a duration longer than that of their Barclays U.S. Aggregate Bond Index benchmark--and outperformance in their credit and nonagency mortgage stakes.
An Honorable Mention or Deja Vu?
Our final contenders, Dan Ivascyn and Alfred Murata of PIMCO, were named Morningstar Fixed-Income Fund Managers of the Year in 2013. Fund Manager of the Year repeats are rare, and Morningstar has never named the same manager in back-to-back years, but strong performance in 2014 makes these managers worthy of mention.
Under Ivascyn and Murata's direction, PIMCO Income (PONAX) has gotten good mileage out of a signature stake in nonagency mortgages, including exposure to commercial mortgages and a mix of prime, Alt-A, and subprime residential debt. Exposure to that sector has helped the fund to one of the best five-year returns in the multisector-bond universe and was an important contributor to the fund’s strong performance so far in 2014. The fund has also benefited from other bets, though. Short exposure to the yen and the euro and a stake in Australian debt have also proved a positive so far in 2014.
Sarah Bush does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.