A Richly Resourced Bond Fund With an Enviable Record
Silver-rated Prudential Total Return Bond's stellar 2017 and impressive risk-adjusted results earned its management team Morningstar's Fixed-Income Fund Manager of the Year honors.
The following is our latest Fund Analyst Report for Prudential Total Return Bond (PDBZX). Morningstar Premium Members have access to full analyst reports such as this for more than 1,000 of the largest and best mutual funds. Not a Premium Member? Gain full access to our analyst reports and advanced tools immediately when you try Morningstar Premium free for 14 days.
Prudential Total Return Bond is run by a fixed-income group that rivals the largest in the industry and boasts massive investments in people and analytics. The fruits of those efforts have earned the fund a good long-term record, and Prudential has improved the fund’s pricing. We are raising the fund’s Morningstar Analyst Rating to Silver.
Prudential's history of running insurance assets--traditionally heavy in corporate bonds--has influenced this fund’s strategy, and the firm boasts at least 80 credit analysts. So even though it's benchmarked against the Bloomberg Barclays U.S. Aggregate Bond Index, it has a credit bias.
The fund's corporate exposure has long topped the benchmark's once high-yield bonds and bank loans are included (neither are in the index), though its managers trimmed credit risk going into 2017 and have favored securitized assets in recent years, too. Corporates and bank loans comprised 43% of the fund as of December 2016, compared with a 28% corporate stake in the index, and roughly a third on average in the intermediate-term bond Morningstar Category.
Though the implications for performance aren't quite the same, the fund had 32% in securitized assets as of December 2016, including the highly rated CLOs, nonagency residential, and commercial mortgage-backed securities. It held 10% in U.S. Treasury and agency securities--versus 66% for the index--down from 43% at the end of 2007.
There's nothing inherently wrong with that profile, but it places the fund on the category's edge in terms of credit risk. And while the market’s rate sensitivity has also risen, the fund’s has trended a bit longer in the past few years. It was buffeted by both rates and credit in 2015, for example, pushing its return below the midpoint of distinct peers in its group. But despite above-average volatility, the fund has survived rough markets without severe or lasting damage: In 2008, it had exposure to rallying Treasuries as its other sectors struggled, placing in the category's middle. Overall, the fund still requires a level of comfort with its composition.
Process Pillar: Positive | Eric Jacobson 04/13/2017
This fund’s managers focus on finding issues that have good fundamentals but generate a healthy amount of income. That gives it a bias toward corporates, securitized assets, and smaller helpings in non-U.S. developed- and emerging-markets debt, with very little exposure to Treasuries and agencies.
The team has long gravitated toward corporate credit. In that context, the managers compare internal credit scores against rating agencies', assign scores based on yield premiums versus the broad market, and build rankings based on liquidity and event risk. Internally developed risk analytics are then applied to portfolios.
The team targets a goal of 150 basis points of outperformance per year over the Barclays U.S. Aggregate Bond Index, ideally averaging contributions of roughly 75 basis points from sector allocation, 40 basis points from subsector and security selection, and 35 basis points from plays on duration, currency, and the yield curve. With the use of its risk models, the team also looks to cap the fund's tracking error at 250 basis points.
Overall, the fund has managed strong execution of a straightforward, well-developed strategy, which has earned it a Positive Process Pillar rating.
The fund's credit emphasis has been more pronounced in recent years, as has a longer duration. After taking that figure to 3.8 years in March 2009, the fund's managers drove it up to 6.3 years as of December 2016, around a half-year longer than the benchmark’s and roughly three quarters of a year longer than the (distinct) intermediate-bond category average.
As of December 2016, the fund held 43% in corporate credit, roughly two thirds of which was investment-grade, and the rest high-yield and bank-loan exposure, reflecting some trimming of credit risk leading up to 2017. Another 14% was in CLOs, classified by Prudential as asset-backeds. Sizing up the kind of highly rated CLO tranches this fund owns can be tricky, though, because they carry structural protection from credit risk but are ultimately supported by leveraged bank loans. Depending on how you assess such quirks, one could argue for viewing the fund’s credit risk more cautiously.
The portfolio was rounded out with asset-backed (roughly 12% after stripping out CLOs) and commercial-mortgage-backed securities (10%) and exposure to foreign government debt (6%) and emerging-markets issues (6%). With only a 1% stake in agency mortgages, and 4% in Treasuries and agency debt, that leaves the fund with a massive underweighting in those sectors relative to its benchmark, and the category, albeit to a lesser degree.
Performance Pillar: Positive | Eric Jacobson 04/13/2017
The fund's long-term record has been attractive: Its trailing returns all place in its category's best quartile. And though its volatility during those periods has been higher than average, it hasn’t been extreme and the fund hasn't suffered serious blows. It earns a Positive Performance rating.
The ride has been a little choppy at times. The fund's duration was 3.8 years in early 2009 and ratcheted up to 6.3 years by December 2016. Many rivals trimmed rate sensitivity, though, producing different relative outcomes.
When Treasury yields spiked between Oct. 8, 2010, and Feb. 10, 2011, for example, the fund's duration was still in the range of 4.5-4.9 years, and its 1.4% loss placed in the best third of distinct funds in the group. Its duration was longer when yields spiked in early 2013, hitting 6.1 years by the end of September from 5.3 years at March 31 of that year. As yields spiked from May through September, the fund lost 5% and trailed its average peer.
And while it trimmed credit risk going into 2017, the fund has been more aggressive there since 2008 when it placed in the category's middle and dipped to the group's bottom half during the third-quarter 2011 credit sell-off. The fund also had some poor relative months when credit sold off in the second half of 2014 and then 2015, but it didn't fare notably worse on a relative basis than during the third quarter of 2011.
People Pillar: Positive | Eric Jacobson 04/13/2017
The fund is run by Michael J. Collins, Robert Tipp, Richard Piccirillo, and Gregory Peters; they also manage other portfolios for Prudential Financial, including Prudential Absolute Return Bond (PADZX). They average more than 20 years of investment experience and are backed by a fixed-income group with big research manpower by virtue of a cadre of portfolio managers and roughly 100 analysts. The group also draws on a large team focused on proprietary analytics, risk management, and performance attribution. The managers’ record and substantial resources earn it a Positive People Pillar rating.
Collins also manages some of the firm's other multisector strategies. He has been at Prudential since 1986 and has experience as a high-yield manager and developing proprietary quantitative international interest-rate and currency models. Tipp has been with the firm since 1991; he heads its global bonds team and drives global rate positioning for several portfolios. Piccirillo has been with Prudential since 1993 and specializes in mortgage- and asset-backed securities. Prior to joining the firm he worked as a fixed-income analyst for Fischer Francis Trees & Watts. Peters has experience as Morgan Stanley's global director of fixed income and economic research and was responsible for the firm's macro research and asset-allocation strategy. His prior experience included stints at Salomon Smith Barney and the U.S. Treasury.
Parent Pillar: Positive | 08/04/2017
The Prudential funds are part of PGIM, the new name for the former Prudential Investment Management, the asset-management arm of conglomerate Prudential Financial. PGIM has notable strengths, including a culture that's positive in many ways, and it has continued to move in the right direction. Our increasing confidence in the firm earns it a Positive Parent rating.
Nearly all of the Prudential funds are subadvised by subsidiaries of PGIM, primarily Jennison Associates, Quantitative Management Associates, PGIM Fixed Income, and PGIM Real Estate. The fixed-income team, with more than half of the firm's fund assets, is well-resourced and risk-aware, while the actively managed fundamental equity funds are run by Jennison with an established, repeatable investment process. The Prudential funds as a group have respectable long-term records.
PGIM has launched a lot of new funds since 2010, about half of its 79 open-end funds (as of June 2017). That's a potential concern, but these new funds have been in areas where the firm already has significant resources.
The Prudential funds are overseen by an engaged, active board. The trustees have pushed for lower fees, and the fund's expenses have been coming down, though they could go even lower. Manager investment in the Prudential funds has also improved from its previous low levels.
Price Pillar: Positive | Eric Jacobson 04/13/2017
The fund's pricing had historically been a mixed bag, with share classes holding half its assets all priced below average relative to their respective peer groups of similarly distributed funds, with the other half of the fund's asset base residing in classes charging above-average fees. Prudential addressed that problem in early 2016, however, contractually limiting expenses on the fund's share classes. They're not required to maintain that agreement, but it would be unusual for a bond fund to raise its prices after such a move. At the new levels, just enough assets are priced below average to push the fund's Price Pillar rating to Positive.
Eric Jacobson does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.