While fixed-income strategies continued to struggle in a volatile market environment during the year ended Sept. 30, the top 10 performing fixed-income managers in the Morningstar Inc.'s separate account/collective investment trust database managed to eke out positive returns for the period.
Eight of the top 10 managers fell within Morningstar's ultrashort bond category, and the first- and third-best performers fell within the research firm's non-traditional bond and multisector bond categories, respectively.
For the year ended Sept. 30, the median return in Morningstar's domestic fixed-income universe was -9.4%; the Bloomberg U.S. Aggregate Bond index returned -14.6% for the period.
Peter Marchese, a senior fixed-income manager research analyst at Morningstar in Chicago, said in a phone interview that the headline of the third quarter — surprisingly — echoed that of 2022's first two quarters.
"The real headline for the third quarter was surging interest rates smashing fixed-income returns for a third consecutive quarter," Mr. Marchese said. "That happening for three quarters in a row is very, very unusual."
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. The range is now 3.75% to 4% following another hike on Nov. 2.
"When rates rise, prices fall," Mr. Marchese said. "When you have rate increases that extreme over one quarter, the returns from all of the major Morningstar fixed-income fund categories were negative for a third consecutive quarter."
The one category that avoided a negative return was the floating-rate bank loan category, which returned zero for the three months ended Sept. 30.
"Zero was the best you could do in the third quarter," Mr. Marchese said. "This sector does well because the interest rates that are paid on the bonds reset every month or every three months."
Bank loans are the most attractive to bond investors in environments like this, Mr. Marchese said.
"They are really high-yield loans with true high-yield ratings of DD and D, they're just secured by a company's assets. In August and September, when the yields on these loans hit 9%, especially during August, that's really what brought buyers into the market, and buyers coming was a factor in boosting prices just to get the third-quarter return to zero."
For the year ended Sept. 30, that relative rally brought the floating-rate bank loan category up to a loss of 3.2%, he said.
The top performer among fixed-income strategies in Morningstar's universe was T. Rowe Price Group Inc.'s dynamic global bond strategy, which chalked up a gross return of 6.06% for the year ended Sept. 30. The portfolio, which is in Morningstar's non-traditional bond category, holds U.S. and international debt securities.
Arif Husain, the London-based lead portfolio manager for the dynamic global bond strategy and a co-portfolio manager on other bond strategies, said in a phone interview the strategy was launched in early 2014 as a reaction to the "taper tantrum" of 2013. The reactionary panic that triggered a spike in U.S. Treasury yields had followed Federal Reserve then-Chairman Ben Bernanke's announcement the Fed would shortly start tapering asset purchases.
"There were some questions about the efficacy of fixed income within the asset allocation and the roles it was playing," Mr. Husain said. "We went really back to that core philosophy of being a diversifier. When the world gets tough, we should get going."
While Mr. Husain said many of the team's peers have focused more on credit, they have focused more on managing duration and overall rate volatility.
"Rates have gone up, but not everywhere," Mr. Husain said. "We've taken a very global perspective. There have been places in the world, particularly in Asia, where we've been able to hide out from the big capital losses that U.S. bonds have seen."
Mr. Husain is also head of international fixed income; and a vice president of T. Rowe Price Group and T. Rowe Price International Ltd.
Ranked second overall was BNP Paribas Asset Management USA Inc.'s mortgage alpha strategy, which posted a gross return of 3.39% for the year ended Sept. 30.
"The focus is really on agency-guaranteed mortgage-backed securities with a very strong focus on security selection ideas," said John Carey, New York-based head of structured securities at BNP Paribas, in a phone interview.
"And this is an asset class where we're not taking credit risk, so the important (performance) drivers are prepayments and volatility," he said.
Mr. Carey said the strategy has benefited because "prepayments have been a lot slower than people thought." Mortgage prepayments are when debtors pay off their loans before the term is complete. He added that will continue to slow as mortgage rates have increased and homeowners are becoming less and less likely to cash out their entire mortgages to refinance since so many are locked in at lower rates.
Ranked third was Carmel, Ind.-based Provident Capital Management Inc.'s absolute bond strategy, which returned a gross 3.19% for the year ended Sept. 30.
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.
The PCM Absolute Bond strategy holds "a proprietary allocation of various domestic and international ETF debt instruments of varying durations and credit quality," with an emphasis on low volatility, consistent income and the preservation of capital through challenging markets, according to the firm's website.
Michael Chapman, CEO and chief investment officer, did not respond to requests for further information.
Federated Hermes Inc.'s trade finance strategy was ranked fourth with a gross return of 2.14% for the year ended Sept. 30.
Trade finance refers to loans that provide short-term financing to support the flow of goods, which serve as the primary security.
Christopher McGinley, Pittsburgh-based vice president, senior portfolio manager and head of the trade finance team, said in an interview that trade finance is the oldest recorded form of capital markets transactions.
"We partner with large global commercial banks that have been doing this in some cases for 100, 100-plus years, it's what commercial banks were meant to do," Mr. McGinley said. The strategy benefits from overall diversification, because the trade finance team looks at all regions of the world, "and we're also diversified on the type of trade finance structure."
