An Upgrade for a Bond Fund With a Checkered Past
Backed by a seasoned team practicing a value strategy, Bronze-rated Metropolitan West Low Duration Bond has dialed down risk.
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Metropolitan West Low Duration Bond is backed by a seasoned and stable team. Though the fund has a checkered past, its process is stronger thanks to a greater focus on diversification and liquidity, and it should be better prepared for the next market rout. As a result, the fund’s Morningstar Analyst Rating is upgraded to Bronze from Neutral.
This fund is steered by a seasoned and stable team, with generalists Tad Rivelle, Steve Kane, Laird Landmann, and Bryan Whalen dialing its risk up or down based on their top-down views. The process is steeped in a valuation-driven philosophy and heavily focused on the team’s security selection within corporates and a wide variety of securitized fare. The fund’s willingness to load up on credit has caused trouble in the past, notably because of individual issuer blowups in 2002 and too much exposure to nonagency mortgage-backed securities in 2008.
However, the team has sensibly limited individual issuer position sizes to 2.5% and has maintained a more cautious overall credit and liquidity profile since then. That owes in part to the team’s concerns over late-stage credit cycle dynamics, so it has taken steps to increase liquidity and improve the quality of holdings in the past few years. That has included an ample allotment to liquid fare--notably around one fourth of assets devoted to U.S. Treasuries over the past few years--as well as gradually upgrading the quality of its securitized sleeve.
Still, the team has tried to take advantage of valuation-driven opportunities. It gradually extended the fund’s duration to 2.3 years from 1.6 years as interest rates sold off in late 2017 and early 2018. The team also scooped up a basket of investment-grade corporates as the sector came under pressure in the first quarter, increasing it by several percentage points to 38%.
While the fund’s long-term track record is still tainted by past blowups, its positioning mirrors what the team is doing on its other funds, which have benefited over the long term by staying focused on valuations and maintaining ample liquidity to take advantage of credit sell-offs.
Process Pillar: Positive | Karin Anderson 06/21/2018
This fund is run by value-oriented investors looking to buy bonds when they're fundamentally cheap and sell when they get expensive. It's benchmarked against the Bank of America/Merrill Lynch 1-3 Year U.S. Treasury Index, but the managers invest heavily in corporate bonds and MBS. The team is willing to venture into riskier areas of the market, including meaningful doses of high-yield and nonagency MBS when it deems valuations attractive, which has given this portfolio a bolder profile than its typical short-term bond peer at times.
That value orientation works partly because it's rooted in fundamental research, particularly in areas where others aren't looking. For instance, when other investors steered clear of nonagencies following the credit crisis, this team invested heavily in the data and tools necessary to evaluate those securities. The managers' value discipline also helps contain risk, and they tend to sell into strength and buy on weakness. Though the fund’s willingness to load up on credit has caused trouble in the past, notably owing to individual issuer blowups in 2002 and too much exposure to nonagencies in 2008, the team has sensibly limited position sizes in individual issuers to 2.5% and has maintained a more cautious overall credit and liquidity profile over the past few years. Therefore, the fund’s Process rating is upgraded to Positive from Neutral.
Citing the backdrop of low volatility and late-stage credit cycle dynamics, the team has dialed down the fund’s risk in recent years. The fund’s stake in U.S. Treasuries was flat for most of 2014 but was stepped up to around one fourth of assets; it has remained around that level since because the team wants to maintain ample liquidity in the portfolio. The team has also gradually brought down the nonagency residential MBS stake to 11% as of May 2018 (down by nearly half over the three-year period). While still one of the team’s favored areas, it indicated that the reduction reflected its wariness of full valuations, and the pace of the change was in keeping with the team’s dollar-cost-averaging approach.
Still, the team has tried to take advantage of valuation-driven opportunities as they present themselves. The team gradually extended the fund’s duration to 2.3 years from 1.6 years as interest rates sold off in late 2017 and early 2018. The fund’s stake in investment-grade corporates also came up by roughly 10 points to 38%; the team added a broad basket of names as the sector came under pressure in the first quarter. Financials are still front and center at 20% of assets, which the team likes because of the ease in finding high-quality and low-duration issues with steadier return profiles.
Performance Pillar: Neutral | Karin Anderson 06/21/2018
This fund has a volatile past. In 2008's financial crisis, technical and fundamental problems with some of the fund's subprime mortgage and lower-rated bonds contributed to a 14.6% loss for the year, 10 percentage points worse than its typical short-term bond Morningstar Category peer. The fund also got burned more than a decade ago by its exposure to troubled telecom and energy names in 2002, including Worldcom. But both periods demonstrate the managers' determination to stand by their analysis through trying times, and shareholders who stuck around benefited from the subsequent bouncebacks.
The fund's commitment to nonagency mortgages has mostly been a tailwind following the financial crisis. Its exposure to this credit-sensitive area of the bond market has been a particular help when risk-taking is rewarded, including in 2010 and 2012 when its returns were double the category norm. That said, the fund kept a more-conservative duration profile than most rivals over the past several years, and it has had less kick from high-yield corporates as the managers have wound that stake below 1% given their views on the credit cycle. This profile has held the fund back compared with most peers over the past three years, and its risk-adjusted track record is still subpar over the past 10 and 15 years given its terrible 2008 showing. As a result, this fund earns a Neutral Performance rating.
People Pillar: Positive | Karin Anderson 06/21/2018
Steve Kane, Laird Landmann, and Tad Rivelle managed portfolios together at Hotchkis & Wiley in the early 1990s (Landmann and Rivelle co-directed the fixed-income department there) before leaving to found MetWest in 1996. Before that, the trio worked together at PIMCO. The specialist ranks, which are each supported by a large squad of experienced analysts, have also been stable. Mortgage specialists Mitch Flack and Bryan Whalen have been with MetWest since 2001 and 2004, respectively. Whalen was promoted to the portfolio generalist team in 2013. Credit research director Jamie Farnham joined in 2002, while government and rates specialist Bret Barker joined in 1997.
Rivelle serves as TCW's fixed-income CIO, but the process has long revolved around teamwork. The generalist managers formulate the team's investment outlook, including deciding how much and what types of risk to take in any given environment, and the sector specialist teams, made up of nearly 50 analysts, traders, and portfolio managers, handle the day-to-day management of securities. No group is an island: For example, the nonagency mortgage team's detailed work on the sector’s fundamentals has informed the generalists' macroeconomic thinking as well as the corporate team's view of mortgage risk on banks' balance sheets. The team’s experience and stability earn a Positive People Pillar rating.
Parent Pillar: Neutral | Karin Anderson 04/13/2018
TCW's new ownership structure isn't likely to trigger drastic changes to TCW's investment teams or executive ranks, but a balance of positive attributes and some concerns support a Neutral Parent Pillar rating.
Japan's Nippon Life Insurance Company bought a 25% stake in TCW from The Carlyle Group at the end of 2017, reducing The Carlyle Group's position to 31% and increasing the TCW employees' stake to 44%. With this deal, TCW continues to maintain control of its investment teams' autonomy and major corporate decisions. As Carlyle is no longer the majority owner, this could mean that TCW has greater command over general business decisions, though both Carlyle and Nippon have board seats.
Fixed income remains the firm's competitive advantage and core competency, which accounted for about 90% of the firm's $205 billion in assets as of December 2017 and its strongest-performing funds, including flagship Metropolitan West Total Return Bond. TCW equity funds are less compelling, though, with lackluster returns in most cases. The firm liquidated a handful of poor-performing growth funds in 2016 and 2017. Plans to diversify the firm's assets under management and revenue stream through the alternatives business hasn't been going well, either. Given the importance of fixed income and its likely heavier influence on corporate culture, it may be difficult to attract top equity and alts investors to the firm.
Price Pillar: Positive | Karin Anderson 06/21/2018
The fund's Institutional share class, which holds nearly two thirds of total assets, comes with a 0.40% expense ratio. That levy is priced 9 basis points below the median of similarly distributed peers. The rest of the fund's assets are housed in the no-load share class, which at 0.61%, is priced just above the group median. That makes for a more significant hurdle in the short-term bond arena, where every basis point counts. Still, given that the majority of shareholders are paying a reasonable fee, the fund’s Price Pillar rating is upgraded to Positive from Neutral.
Karin Anderson does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.