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Met West Team Managing Massive Inflows Well

Metropolitan West Total Return Bond has continued to steer the fund in a predictable fashion even as assets have soared since Bill Gross’ departure from PIMCO. 

Karin Anderson, 12/25/2016

Metropolitan West Total Return Bond benefits from an experienced team of managers and analysts and a time-tested investment approach. This team, led by Tad Rivelle, Steve Kane, Laird Landmann, and Bryan Whalen, has a good deal of flexibility compared with the Bloomberg Barclays U.S. Aggregate Bond Index benchmark. The fund received the most inflows of any actively managed fund in the intermediate-bond Morningstar Category following Bill Gross' departure from PIMCO, with assets increasing by roughly 90% between late September 2014 and April 2015. The inflows have continued since then, albeit at a much slower pace, and the team has continued to steer the fund in a predictable fashion, dialing risk up or down based on its views on the credit cycle. Despite a small hike in fees, the expense ratio on the fund’s institutional shares is still reasonable. All told, the fund receives a Morningstar Analyst Rating of Gold.

This fund’s inflows were massive between late 2014 and through the spring of 2015, and this team managed them well, thanks in part to good security selection in its corporate sleeve and strength from its midteens nonagency mortgage stake. The fund's reduced stake in less-liquid nonagency mortgages (14% as of mid-2014 to 6% as of October 2016) raised the concern that the fund’s size has crowded it out of that niche. The team has argued that the reduction reflected its wariness of full valuations rather than capacity constraints, and the pace of the change was in keeping with the team’s dollar-cost-averaging approach. The team has been more cautious in other areas as well, including efforts to upgrade the quality of the fund’s stakes in corporates (23%, including 2% in high yield), asset-backed securities (6%), and commercial mortgage-backed securities (6%), as well as keeping duration one half year short of the index.

The fund’s more conservative profile has resulted in decent, though not stellar, returns compared with peer funds during the past few years, but over the long term, the team’s eye for value and well-timed moves into credit have paid off handsomely.

Process Pillar: Positive | Karin Anderson 12/19/2016 

This fund is run by value investors looking to buy bonds when they're fundamentally cheap and sell them when they get expensive. It's benchmarked against the Bloomberg Barclays U.S. Aggregate Bond Index, but its managers actively adjust the fund's duration relative to the index and have the flexibility to invest outside it. That can result in a more aggressive credit profile than the category norm. The value orientation works partly because it's rooted in fundamental research, particularly in areas where other managers aren't looking. For instance, the team got a jump-start on investing heavily in the data and tools necessary to evaluate nonagency residential mortgage-backed securities as others steered clear of the sector's junk credit ratings.

The managers dial risk up and down in predictable fashion. When yield spreads offered by corporate bonds over U.S. Treasuries reached historic lows in 2007, for example, they reduced the fund's corporate stake to an all-time low of 7% by early 2008, then reversed course as spreads widened in 2008. Similarly, their pessimism about the economy caused them to lengthen the fund's duration before the financial crisis; since the 10-year Treasury dropped below 2% in 2011, they've kept it shorter than the index's and have taken steps to reduce credit risk as well. The fund's flexibility and disciplined approach to valuations support a Positive Process Pillar rating.

Since late 2013, the team has dialed down both interest rate and credit risk based on its views on late-stage credit cycle dynamics. The team has kept duration one half to one year short of the Bloomberg Barclays U.S. Aggregate Bond Index due to the team’s wariness of the Fed hiking cycle. In terms of credit quality changes, a notable shift was the reduction in the less-liquid nonagency mortgages stake (14% as of mid-2014 down to 6%), which raised the concern that the fund’s size has crowded it out of that niche. (This fund saw massive inflows in the fall of 2014 and spring of 2015, pushing its assets up by roughly 90% during that period.) The team has argued that the reduction reflected its wariness of full valuations rather than capacity constraints, and the pace of the change was in keeping with the team’s measured, dollar-cost-averaging approach.

The fund’s stake in U.S. government bonds has come down some since the period of its massive inflows, and as usual, its 29% still lands well below the index weighting of 36%. Meanwhile there haven’t been any dramatic changes to the fund’s stakes in corporates (23% including 2% in high yield), asset-backed securities (6%), and commercial mortgage-backed securities (6%), though the team has made efforts to upgrade the credit quality within those sleeves during the past three years.

Performance Pillar: Positive | Karin Anderson 12/19/2016 

This fund’s management team has made bigger moves into unloved areas of the market, but it's also made adjustments to temper the effects of such boldness. It bought battered nonagency mortgages early in 2008, although exposure to long U.S. Treasuries and credit default swap protection purchased against commercial mortgages helped keep the fund from going off the rails compared with other intermediate-term bond funds that year. The team has also shown conviction through trying times. In 2011, the fund's short duration and more credit-sensitive holdings weighed on its returns, but the team didn't capitulate on those bets, which helped the fund rocket back in 2012.

A cautious interest-rate stance plus a more conservative credit profile compared with its own history has made for solid rather than spectacular results during the past few years. Its cautious stance on rates paid off when rates shot up in 2013, but that has mostly worked against the fund since early 2014. That said, good selection within its corporate holdings and the general strength of its nonagency stake has helped offset that. Over time, the team’s patience and eye for value have paid off: The fund's total returns during the trailing five- and 10-year periods through November 2016 rank in the category’s top decile and handily beat the Bloomberg Barclays U.S. Aggregate Bond Index, supporting a Positive Performance rating.

People Pillar: Positive | Karin Anderson 12/19/2016  

Tad Rivelle, Laird Landmann, and Steve Kane managed portfolios together at Hotchkis & Wiley in the early 1990s (Landmann and Rivelle co-directed the fixed-income department there) before leaving to found MetWest in 1996. Before that, the trio worked together at PIMCO. The specialist ranks, which are each supported by a large squad of experienced analysts, have also been stable. Mortgage specialists Mitch Flack and Bryan Whalen have been with MetWest since 2001 and 2004, respectively. Whalen was promoted to the portfolio generalist team in 2013. Credit research director Jamie Farnham joined in 2002, while government and rates specialist Bret Barker joined in 1997.

Rivelle serves as TCW's fixed-income CIO, but the process has long revolved around teamwork. The generalist managers formulate the investment outlook, including deciding how much and what types of risk they want to take in any given environment, and the sector specialist teams, made up of more than 50 analysts, traders, and portfolio managers, handle the day-to-day management of securities. No group is an island: For example, the nonagency mortgage team's work on the sector’s fundamentals has informed the generalists' macroeconomic thinking as well as the corporate team's view of mortgage risk on banks' balance sheets. The team’s experience and stability earn a Positive People Pillar rating.

Parent Pillar: Neutral | Karin Anderson 05/28/2015 

Corporate changes, a raft of inflows, and average fees all support a Neutral Parent rating for TCW. The firm got new owners in 2013 when Societe Generale sold it to private equity funds managed by the Carlyle Group and TCW management. Some high-level departures followed, including a chief risk officer and chief compliance officer, but key portfolio managers, including the MetWest founders, signed five-year contacts. The firm also made equity awards, which should help ensure key team members stay put; indeed, the investment team has been stable. There are no concrete plans for Carlyle to sell its stake in TCW.

Meanwhile, the firm has benefited since competitor Bill Gross left PIMCO in September 2014. Metropolitan West Total Return Bond MWTIX has received the most inflows of any actively managed fixed-income fund in the months since Gross' departure. The open-end fund had $66 billion in assets as of April 2015, up roughly 90%. That team has managed the flows well, though its ability to traffic in less-liquid markets bears watching.

Elsewhere, the legacy TCW team has been less stable and its funds have been less successful over the long term. Manager ownership across the fund complex has improved but still lags many competitors'. Fees for some of the firm's largest fixed-income offerings are competitive, but overall fees are average.

Price Pillar: Neutral | Karin Anderson 12/19/2016 

Roughly 60% of this fund's assets reside in the Institutional share class, which comes with a 0.43% expense ratio, up by a few basis points since 2014. Given the fund's substantial surge in inflows between late 2014 and early 2015, and continued inflows throughout much of 2016, even this small increase is disappointing. It's not the cheapest actively managed core bond fund in this channel, but remains 7 basis points cheaper than the norm and therefore receives a Positive Price Pillar rating.

The fund's no-load shares, which account for one fifth of assets, charge 0.66%, which has also ticked up from a couple years ago. This expense ratio lands right at the median for no-load share classes in the intermediate-term bond category.

 

Karin Anderson is a senior mutual fund analyst with Morningstar.

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