Short-duration, multisector bond strategies come out on top in 2022

The top-performing fixed-income managers in 2022 managed to post positive returns during a historically poor year for the asset class, according to Morningstar Inc.'s separate account/collective investment trust database.

Five of the top 10 managers fell within Morningstar's ultrashort bond category (down from eight of 10 the previous quarter), while three of the top 10 fell within the multisector bond category, one within the non-traditional bond category, and one strategy – the top overall – fell within Morningstar's muni national long bond category.

For the year ended Dec. 31, the median return in Morningstar's domestic fixed-income universe was -7.5%; the Bloomberg U.S. Aggregate Bond index returned -13% for the period.

Peter Marchese, a senior fixed-income manager research analyst at Morningstar in Chicago, said in a phone interview that the weak performance for the full year could be attributed not only to rising interest rates, but the swiftness of that rise.

"It's the highest rate of rate increases we've seen in decades — at least in the last 25 years — and so when rates rise that fast that pulls down the prices of all bonds that have a maturity date of one year or longer," Mr. Marchese said, "and it pulls them down to negative territory that we haven't seen in many, many years."

In the third quarter, the Federal Open Market Committee raised the target range for the federal funds rate by 75 basis points in July and again in September to a range of 3% to 3.75%. Those hikes followed a 75-basis-point increase in June, a 50-basis-point increase in May and a 25-basis-point increase in March.

In the fourth quarter, however, inflation cooled slightly and the Fed's feverish pace slowed down accordingly after an additional 75-basis-point increase in November. In December, the Fed raised rates only by 50 basis points. Since then, the Fed in February slowed down even more with a 25-basis-point increase to a range of 4.5% to 4.75%.

"The market had what was a risk-on rally in the fourth quarter, where investors embraced bank loans, high yield and corporate bonds," Mr. Marchese said. "In the third quarter … the market really got scared about the likelihood of a recession and once the inflation numbers in November came, moderated just a bit."

Bonds were incredibly cheap during the fourth quarter, Mr. Marchese said.

"There were yields in high yield that were 8%," he said. "Institutional investors jumped in and bought these attractively priced corporate bonds of all flavors."

The median return among domestic high-yield strategies in Morningstar's universe for the year ended Dec. 31 was -9.3%. But the median return for the fourth quarter was 4.1%, above the 2.2% for the broad fixed-income universe.

The top performer among domestic fixed-income strategies was New York-based 16th Amendment Advisors LLC's Vicksburg strategy, which posted a gross return of 46.03% for the year ended Dec. 31. The strategy also topped the list of top managers for the five years ended Dec. 31, with an annualized gross return of 38.38%.

John J. Lee, a co-founder and managing member of the firm, said in an email that the strategy benefited from a "cautious and bearish outlook on interest rates in general. Further, it took advantage of the disarray in the marketplace due to sharply rising rates and historically volatile markets."

The strategy had also topped the lists for the one year and five years ended Sept. 30, 2021, and in an interview that November, Mr. Lee said Vicksburg is a total return, institutional fixed-income strategy.

It holds investment-grade municipal bonds, corporate bonds and their hedges in a strategy that is targeted to investors looking for non-correlated high-grade fixed-income exposure, he said.

Ranked second was T. Rowe Price Group Inc.'s dynamic global bond strategy, which chalked up a gross return of 4.66% for the year ended Dec. 31. The portfolio, which is in Morningstar's non-traditional bond category, holds U.S. and international debt securities.

Scott Solomon, Baltimore-based co-portfolio manager of the dynamic global bond strategy, said in a phone interview that duration range was key for the strategy.

The strategy was launched in 2014 following the "taper tantrum" of 2013. The reactionary panic that triggered a spike in U.S. Treasury yields followed Federal Reserve then-Chairman Ben Bernanke's announcement the Fed would shortly start tapering asset purchases.

The manager launched the strategy in order to manage duration and rate volatility on a global scale.

"We have a pretty significant duration range that we can use from negative one-year duration to six years," Mr. Solomon said. "A lot of strategies don't necessarily have that big of a range, and we are fully capable of using that range."

"The other thing we're able to do — because we have a pretty diverse and significantly large global fixed-income team — we were able to identify some pretty significant duration hideouts," said Mr. Solomon. "For example, Korea, China, (their rates) are not quite as high as in the U.S. and Europe."

Federated Hermes Inc.'s trade finance strategy was ranked third with a gross return of 4.24% for the year ended Dec. 31.

Christopher McGinley, Pittsburgh-based vice president, senior portfolio manager and head of the trade finance team, said in a phone interview that the strategy "is best thought of as a subset of the loan market, so we are providing relatively short-term floating rate loans to facilitate the cross-border flow of goods."

"Trade finance loans are financing a specific trade flow or asset conversion cycle, so we're not necessarily lending to a company for general corporate loan purposes," Mr. McGinley said.

While much of the Western world thinks of imported goods as luxury items, Mr. McGinley said the trade flow is about essential items like energy and food, and that makes it a very real and transparent part of the global economy.

The team examines "who's buying, how much, what quality, what price is agreed upon before funds are dispersed. There's not a lot of volatility in the market and it doesn't have a lot of correlation to financial asset classes."

That lack of correlation means the trade finance strategy tends to shine in down markets, he said.

Ranked fourth was Carmel, Ind.-based Provident Capital Management Inc.'s absolute bond strategy, which returned a gross 3.44% for the year ended Dec. 31.

In the strategy's Morningstar profile, the firm said it uses a multifactor quantitative approach to offer an attractive alternative to hedge funds, mutual funds and traditional buy-and-hold strategies.

Michael Chapman, CEO and chief investment officer, did not respond to requests for further information.

Potomac Fund Management Co. ranked fifth for the year ended Dec. 31. Its income plus strategy returned a gross 3.03% for the period.

The Miami-based manager on its website describes the income plus strategy as one that employs a "core and explore" philosophy using a suite of underlying mutual funds.

The core position, which holds between 70% and 80% of the portfolio, primarily utilizes fixed-income positions but also will employ liquid alternative holdings including long/short, managed futures, merger arbitrage and market-neutral strategies.

The remainder uses momentum to rotate among a group of tactical funds. The website also notes that the underlying funds employ risk management techniques including the use of inverse and cash positions. During adverse market conditions, the strategy could hold as much as 100% in cash, according to the website.

Manish Khatta, CEO and CIO, did not respond to requests for further information.

Ranked sixth was Global Value Investment Corp.'s MIAM focused fixed-income value strategy, which returned a gross 2.41% for the year ended Dec. 31.

J.P. Geygan, Milwaukee-based senior vice president and chief operating officer, said in a phone interview they are a fundamental, value-based manager that takes concentrated positions in high-conviction ideas.

The strategy purchases corporate debt the firm thinks is mispriced in public markets.

"We hold it to maturity, or until such a time that the yield to maturity isn't compelling enough to hold anymore," Mr. Geygan said.

The strategy is concentrated with low turnover, Mr. Geygan said. An example of a holding that did well for the strategy was PBF Holding Co., issuer of the debt for PBF Energy Inc., one of the largest independent refiners in the U.S., he said.

"We bought the debt in January (2022) at 78 cents to the dollar and ended the year close to par," Mr. Geygan said. "We bought it very inexpensively because there was a market misunderstanding of a particular regulatory problem in which they participate. As the price for refined products went through the roof, they were significant beneficiaries."

For the five years ended Dec. 31, six of the top 10 strategies fell within Morningstar's high-yield category.

After the 16th Amendment Vicksburg strategy at the top of the list, Thomas J. Herzfeld Advisors Inc.'s fixed-income composite was ranked second with an annualized gross 6.8% for the five years ended Dec. 31. Those were followed by the MIAM focused fixed-income value strategy, 5.47%; Herzfeld Advisors' tax-exempt composite, 5.11%; and L&S Advisors Inc.'s short-duration high-yield strategy at 4.71%.

For the five years ended Dec. 31, the median annualized return in Morningstar's domestic fixed-income universe was 1.31%; the Bloomberg U.S. Aggregate Bond index returned an annualized 0.02% for the period.

Within Morningstar's collective investment trust universe, the most represented Morningstar categories were bank loans and short-term bonds, each of which had four of the top 10 trusts for the year ended Dec. 31. There was also one inflation-protected bond and one ultrashort bond fund.

For the year ended Dec. 31, the median domestic fixed-income CIT return within Morningstar's universe was -12.32%.

Northern Trust Asset Management's Short-Term Investment Fund CIT and State Street Global Advisors' Cash Series Short-Term Investment Non-Lending Index C were tied for the top spot on the list, each posting a net return of 1.81% for the year ended Dec. 31.

Those were followed by Fidelity Institutional Asset Management's Target Date Treasury Bill Index Commingled Pool, at a net 1.34%; FIAM's Floating Rate High Income Pool, 0.41%; and T. Rowe Price's floating rate Tr-Z, -0.67%.

For the five years ended Sept. 30, FIAM's Floating Rate High Income Pool was the top performer with an annualized net return of 3.7%.

The median annualized return among Morningstar's domestic fixed income CITs for the five years ended Dec. 31 was 0.69%.

All data for Pensions & Investments' top-performing managers report are provided from Morningstar's global separate account/collective investment trust database. Data for the separate account and CIT rankings on which this story is based were pulled Feb. 2.