“If we have developed a system that more than 50% of the time allows us to avoid the blowups in the bond markets, then we win and — more importantly — our clients win.”
Michael Temple certainly lives up to the Pioneer Investments moniker. The Boston-based firm’s director of credit research has a blunt, no-nonsense style that stems from more than 20 years in the credit space.
“I’ve been through three pretty significant credit cycles in that time,” he explains. “It always struck me that in doing so, if you look over a full business cycle, that owning high-yield and/or high income investments were a very attractive proposition, but there were times when investors were clearly getting a very bad experience.”
The “struggle” for many investors, he adds, was when to get out; “When was the time to reduce their high-yield exposure, or to that of bank loans or emerging markets. To larger degree, they’re all sort of the same ilk when markets are falling out of bed. You’ve probably heard the term, ‘everything correlated to one in 2008.’”
Temple, portfolio manager of Pioneer Dynamic Credit Fund, explained that the traditional way bond fund managers tended to navigate those markets and anticipate the downturn in the credit cycle was to do a couple of things. One was to raise the quality of the portfolio and look for “BBs or high-grade corporate credit or a multisector fund that would sell their high-yield exposure and move into higher quality government bonds.”
The other way, he notes, it is to reduce the manager’s position sizes so they reduce their exposure to idiosyncratic risk, or the risk of any specific sector of any specific company.
“Maybe what you do is globalize the portfolio as well and move into different continents, assuming these businesses and interest rate cycles could be at different points is time. However, I think the lesson learned in 2008 is that this isn’t really sufficient. I think that to a larger degree, to change the asset quality and asset allocation on the fly will be almost impossible, particularly in these markets that are increasingly illiquid from all the investment banks withdrawing liquidity from the marketplace.”
What Pioneer, on the other hand, tries to do is understand a better way to manage risk, or at least some additional tools that it can use to manage risk.
“Frankly, at the end of the day, if you think about it from a solutions standpoint, what do investors want? Well, they want to be exposed to the high-income parts of the marketplace for as long as possible. And then they want someone to tell them basically, ‘all right, time to get out.’”
And that, Temple says, is what the fund provides: exposure to various high income producing areas of the market, including high yield, and bank loans, convertibles, preferred stocks and emerging markets, while also making the various allocation shifts based on where it thinks the values lie and where the risks are.
“At the end of the day, what we’re telling investors is that, “Don’t worry, we’ll take care of the credit risk involved in the portfolio and we’ll do it in the traditional ways; through asset allocation and making sure that were taking care of the security side of things. However, we also have an additional way of doing it; one that is very efficient and very nimble in that it takes advantage of highly liquid derivative markets that don’t have counterparty risk associated with [them].”
It’s just one more layer of risk management, he concludes.
“The beauty of this is that we can actually change the character of the portfolio virtually instantaneously, so I don’t have to depend upon liquidity in the markets order to change my portfolio. That is dynamic credit in a nutshell.”
Check out Deconstructing DFA’s Secret Sauce on ThinkAdvisor.