As interest rates rise and investors withdraw billions from bond funds, Goldman Sachs Asset Management is asking them to take a closer look at fund managers’ performance and asset allocations before heading for the exits.
Investors with portfolios of laddered individual bonds face the same duration risk as those with bond funds, and the only difference is that investors in bond funds can check the NAV daily whereas those in laddered portfolios only see their returns posted periodically on statements, said Jonathan Beinner, co-head of GSAM Global Fixed Income and Liquidity Management, at a press briefing in New York on Thursday.
“A lot of investors are exposed to interest rate risk and are just not aware of it,” said Beinner, who also serves as co-portfolio manager for Goldman Sachs Strategic Income Fund (Class A: GSZAX). “The duration is there whether you choose to acknowledge it or not. In the same way that a bond fund doesn’t mature, a laddered bond portfolio doesn’t mature.”
The GSZAX fund, which just marked its third-year anniversary on June 30, has earned 3.44% year to date as of July 17, according to Bloomberg data. Morningstar reports that the fund’s assets total $6 billion, and the expense ratio is 0.99%, while the turnover rate is 727%. The nontraditional fund ranks in the top 3% of the 241 funds in its Morningstar category.
Bogleheads Agree With Goldman
Even the Bogleheads community of individual investors, so named in honor of Vanguard founder John Bogle, agree that fixed income investors should take a close look at their bonds or bond funds before deciding whether to stay or go.
“The major factors in deciding between owning a bond fund versus individual bonds are: diversification, convenience, costs, and control over maturity,” says the Bogleheads wiki “Individual Bonds vs a Bond Fund.” “There is a common belief (promoted by Suze Orman, among others) that owning individual bonds is less risky than a bond fund, but this is not necessarily true if an appropriate bond fund or collection of funds is chosen. Duration is an essential attribute for understanding the riskiness of a fund or ladder over time.”
Last Friday, Morningstar reported that June long-term bond fund and bond ETF flows had seen their worst month since 2008. Investors withdrew an estimated $43.8 billion from taxable-bond funds and $16.4 billion from municipal-bond funds, making June the worst month on record for bond funds in terms of total outflows. Long-term funds overall shed $47.3 billion, the largest monthly outflow since $105.6 billion in October 2008.
Floating Rate Loans, Flexible Mandates
GSAM’s Beinner acknowledged that the bond market’s 30-year-long “liquidity supercycle” was coming to an end, which explains why his firm has adopted an “unconstrained" fixed income strategy.
“An unconstrained approach reduces the baseline for duration risk to zero and allows for a more diverse set of global opportunities to drive returns,” writes the GSAM fixed income team in an April white paper, “The Case for Unconstrained Fixed Income.”
Specifically, Goldman is currently invested in bank loans and leveraged loans because they are floating-rate vehicles. In addition, the firm seeks hedged instruments such as nongovernment derivatives as well as currency swaps that offer an opportunity to invest outside of the U.S.
Similarly, smaller firms are adopting nontraditional strategies in fixed income in order to manage risk as interest rates climb higher. (Beinner predicts that within a couple of years, the new normal for long-term debt will be closer to 5%.)
DDJ Capital Management, a Waltham, Mass.-based institutional investment manager specializing in high-yield credit and senior loans, reported Thursday that it is seeing clients increasingly embrace a broader fixed income strategy that encompasses both traditional high-yield bonds and floating rate bank loans as they seek yield.
“We are finding heightened interest from U.S. and international investors in flexible mandates that allow us to take advantage of market dynamics, in addition to continued demand for separate high-yield and bank loan strategies as investors seek income in this rate-challenged environment,” said David Breazzano, DDJ’s president and chief investment officer, in a statement.
As of June 30, DDJ managed approximately $6 billion, including $1.6 billion in bank loans across all of its investment strategies and approximately $114 million in a dedicated senior loan strategy.
Read June Long-Term Fund Outflows Worst Since 2008: Morningstar at AdvisorOne.