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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.

Performance Pillar: Positive | Brian Moriarty 02/24/2017  
From Bill Martin’s start date in August 2011 through January 2017, the fund had one of the strongest records in the intermediate-term bond Morningstar Category. Over that period, it returned 4.0% annualized, beating 91% of peers and easily outpacing the 2.5% return of the benchmark Bloomberg Barclays U.S. Aggregate Bond Index. Some of that outperformance can be attributed to the increased credit risk the fund is allowed to carry, which is higher than many peers’. But Martin’s flexible use of the fund’s mandate has helped it hold up better than many peers during credit sell-offs. For example, the fund’s tiny 0.6% return in 2015 (a rocky year for credit markets) was still better than three quarters of peers and edged out the index.

While performance has been impressive over Martin’s tenure, the fund’s heavier focus on below-investment-grade debt could hurt it in a credit-driven sell-off. At the end of January 2017, roughly 19% of the fund was in below-investment-grade debt, more than twice the typical peer’s stake. And given the fund’s 10% stake in emerging-markets debt, which had a strong showing in 2016, it is also sensitive to sell-offs in that sector.

Based on the fund’s strong returns and attractive risk profile (as measured by Sharpe ratio and standard deviation), it earns a Performance Pillar rating of Positive.

People Pillar: Positive | Brian Moriarty 02/24/2017 
Bill Martin became lead manager in August 2011. He is supported by comanagers John Cerra, who was previously lead manager on the fund, and Kevin Lorenz, who oversees the firm’s high-yield team and is lead manager on TIAA-CREF High Yield TIHYX. Martin, who joined TIAA in 2004 and has over 20 years of investment experience, leads the firm’s fixed-income portfolio management team and was previously head of the mortgage-backed securities sector.

As lead manager, Martin is responsible for the fund’s sector allocations and makes the final decisions on risk exposure and holdings. However, sector managers are responsible for security selection within their respective sectors. There are 11 sector managers, who in turn are supported by 36 senior analysts and 15 junior analysts. The sector managers average over 20 years of industry experience, while the senior analysts average more than 10 years of experience.

The team has stabilized after a period of turnover, which included the 2013 departure of Steve Raab, who headed the firm’s mortgage effort after Martin became lead manager. It has also expanded the number of traders dedicated to fixed income, from 10 in 2015 up to 13 as of January 2017. Based on the size and experience of the team, the fund earns a People Pillar rating of Positive.

Parent Pillar: Neutral | 02/02/2015  
TIAA-CREF's mutual funds represent less than 15% of the $612 billion in assets under management as of June 20, 2014. Its primary businesses are managing assets for teachers and public employees’ retirement plans as well as insurance-related products. CEO Roger Ferguson wants to grow the firm’s mutual fund assets by better-utilizing broad capabilities in other areas of the asset-management business. He set this goal in 2010.

The mutual funds have been slow to gain traction outside their core higher-education pension market, but the firm’s October 2014 acquisition of Nuveen Investments brings improved third-party distribution channels and a means for promoting its funds. TIAA-CREF and Nuveen intend to operate essentially as separate entities for the foreseeable future, and retention plans should keep key Nuveen management in place for several years.

TIAA-CREF’s corporate culture meets industry standards, and the firm’s nonprofit heritage has helped align its interests with those of its customer base. The firm's fund managers are increasingly investing in the funds they run. The fund lineup is sound but not flashy. For example, the firm launched an emerging-markets debt fund in September 2014 to better diversify its target-date and 529 college-savings investments. A very independent fund board, low costs, and clean regulatory history contribute to a solid foundation.

Price Pillar: Positive | Brian Moriarty 02/24/2017 
A majority of the fund’s assets are in its Institutional share class, which has a 0.31% expense ratio and a Morningstar Fee Level of Low. The remaining assets are split among share classes that have different fee levels, but all of them have expense ratios below the intermediate-term bond median fee of 0.71%. The fund earns a Price Pillar rating of Positive thanks to low fees for the bulk of assets.

 

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