Quick Take:Bond funds have performed well this year, receiving interest from investors weary of equity markets. While some observers are concerned that the Federal Reserve may raise interest rates next year, portfolio manager Varun Mehta believes rates could actually decline in 2003 because of the continued weakening of the economy. As manager of the Mason Street Fds Select Bond Fund/A (MBDAX), he believes that high-quality fixed-income securities could still be attractive.
For the 12-month period ended September 30, the fund gained 11.6%, versus 6.7% for the average intermediate-term high-quality bond fund. For the three-year period ended September 30, the fund delivered an average annualized return of 10.4%, versus 8.1% for its peers. Mehta has managed the $75-million portfolio, which carries a 4-Star ranking from Standard & Poor’s, since its inception in March 1997.
The Full Interview:
S&P: What is your current asset allocation?
MEHTA: As of September 30, we had 90.9% in bonds and 9.1% in cash. This is a core investment-grade bond portfolio, of about 100 holdings, so we have a mix of government securities, corporate bonds, mortgage securities and asset-backed securities. We typically do not invest in any junk bonds.
S&P: How do you construct the portfolio?
MEHTA: We use a combination top-down/bottom-up methodology. The top-down side involves our views on the economy, monetary and fiscal policy, and inflation. We then determine parameters, such as total duration exposure, yield curve exposure, etc., and our asset-allocation profile based on our macroeconomic outlook.
On the bottom-up side, our research staff does a detailed credit analysis on the corporate bond portion of the fund. Within the government bond segment, we basically invest in U.S. Treasurys. Among mortgage securities, we focus primarily on GNMA securities.
Overall, we currently have about a 40% risk-weight in corporate bonds, which represents an underweight; 15% in mortgage-backed securities, a neutral weight; and the remainder in government securities, an overweight.
Within the corporate sector, we focus on leverage, return on equity, and return on capital measures to determine companies we want to own. We look at liquidity as well. We want to make certain a company has sufficient liquidity so it is not exposed to refinancing risks when it comes back to the market to raise money to pay off existing debt.
Within the mortgage sector, the focus is primarily on refinancing risk. Our government exposure is predicated on the shape of the U.S. yield curve.
S&P: What are some of your top individual holdings?
MEHTA: As of September 30: U.S. Treasurys, various, 41.4%; Federal National Mortgage Assoc., various, 3.4%; Coca-Cola Enterprises, various, 2.7%; GNMA, various, 2.7%; and Occidental Petroleum, 6.75%, 1/15/12, 2.5%.
S&P: What is your fund’s duration?
MEHTA: The average duration is about 6 years, which longer than our benchmark, the Lehman Brothers Aggregate Bond Index. It is also longer than our universe of comparable bond funds, the Lipper corporate A-rated universe, which has an average duration of 5.1 years.
S&P: What is the fund’s average credit quality?
MEHTA: Including the Govt. Treasurys, the average credit quality would be AAA. Excluding the government securities, I would say it is an A+.
S&P: What is the fund’s average maturity?
MEHTA: Roughly 11 years.
S&P: Assets have been pouring into bond funds as stocks and interest rates have declined. Has your fund received a large cash flow this year?
MEHTA: We have been receiving quite a lot in new inflows this year. This is one of the reasons we currently have had a slightly higher cash stake.
S&P: To what do you attribute the fund’s outperformance?