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An Upgrade for This Value-Driven Bond Fund

A large and experienced team, impressive record, and below-average expenses help TIAA-CREF Bond Plus earn a Bronze rating.

Morningstar, 03/05/2017

TIAA-CREF Bond Plus has distinguished itself as a solid choice among intermediate-term bond funds. TIAA veteran and lead manager Bill Martin, supported by a large and experienced team, has used a value-driven strategy to guide the fund to an impressive record since taking over in August 2011. Add in below-average expenses for most investors, and the fund earns an upgrade to a Morningstar Analyst Rating of Bronze from Neutral.

As lead manager, Martin is responsible for allocating across sectors and controlling interest-rate and credit-quality risks. Holdings can include corporate bonds, mortgages, securitized debt, and foreign bonds, and the strategy targets a 20%-30% allocation to “plus” sectors: high-yield bonds, bank loans, and emerging-markets debt. That allocation can shift up and down depending on where Martin sees relative value opportunities, but it is one of the higher plus sector ranges in the category (these generally max out at 20% or 25%).

So far, investors have been well compensated for those risks. From Martin’s start date in August 2011 through January 2017, the fund’s 4.0% annualized return beat 91% of the peer group, which had a median return of 2.9%. Some of that outperformance can be attributed to the fund’s increased credit risk relative to peers, but Martin has also deftly navigated the fund through turbulent credit markets. For example, it held up better than 75% of peers during 2015, a difficult year for credit markets, because Martin reduced the plus sectors close to the 20% minimum and increased U.S. Treasuries to 14% by the end of the year.

The fund’s success stems from a consistent, value-driven process as well as an experienced and deep team. In addition to Martin, the fund is supported by a sizable team that includes 11 sector portfolio managers, 36 senior analysts, and 15 junior analysts. The experienced sector portfolio managers are responsible for security selection within their areas of expertise, but Martin approves everything that goes in and out of the fund.

Process Pillar: Positive | Brian Moriarty 02/24/2017 
Lead manager Bill Martin is responsible for the fund’s sector allocations as well as decisions on overall exposure to credit and interest-rate risk. The fund can invest in everything from corporate bonds and mortgages to municipal bonds and emerging-markets debt. The various sector managers are responsible for individual security selection, but Martin approves all buys and sells to make sure each holding is appropriate for the portfolio. While Martin does use macroeconomic research from the firm’s economists, allocation is driven by where he sees the best relative value opportunities across myriad fixed-income sectors.

The strengths of the value-driven strategy were on display the last two years. Martin kept the fund’s exposure to higher-yielding sectors on the low end of its historic range throughout 2015, which was a difficult year for credit markets, then began buying beaten-down assets at the end of 2015 and early 2016. The allocation to “plus” sectors (high yield, bank loans, and emerging-markets debt) got close to the 30% limit. As prices recovered over the course of 2016, Martin reduced exposure to the plus sectors and increased exposure to higher-quality defensive securities, which benefited the fund in the latter half of 2016. The well-reasoned, value-driven approach has worked well over time, and the fund’s Process Pillar rating is upgraded to Positive from Neutral.

The fund’s mandate allows it to take on a higher level of credit risk than many peers in the intermediate-term bond Morningstar Category. High-yield corporate bond exposure (including bank loans) will generally be between 10% and 20% of assets, while emerging-markets exposure is often between 5% and 15%. The total “plus” sector exposure targets 20%-30% of assets. It clocked in at 19% at the end of December 2016 and included high-yield, bank loan, emerging-markets, and non-agency debt. Martin had this defensive tilt in place because he didn’t see as much value in the plus sectors as he did in early 2016. Many core plus funds allocate a maximum of 20% or 25% to the “plus” sectors, so this fund often has above-average credit risk compared with its peers.

At the end of December 2016, the fund also had assets in U.S. Treasuries (17%), mortgage pass-throughs (16%), commercial mortgage-backed securities (9%), and asset-backed securities (7%). The Treasury stake will often swing up or down when Martin wants to position the fund conservatively or aggressively. Unlike some peers, Martin and the team don’t try to predict the direction of interest rates or make extreme duration bets, and the fund’s duration will generally stay within 15% of the Bloomberg Barclays U.S. Aggregate Bond Index. At the end of 2016, duration was 5.5 years compared with the benchmark’s 5.9 years.

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