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An Attractive--If Aggressive--Bond Fund

Experienced management and a successful often-contrarian, value-driven approach make Silver-rated Loomis Sayles Strategic Income a fine choice for patient investors.

Sarah Bush, 04/10/2017

The following is our latest Fund Analyst Report for Loomis Sayles Strategic Income Fund NEZYX

Loomis Sayles Strategic Income lands at the aggressive end of the multisector-bond Morningstar Category, typically taking on even more credit and equity risk than its intrepid sibling Loomis Sayles Bond LSBRX. For those with the requisite patience, the team’s depth of experience and its success plying an often-contrarian, value-driven approach support a Morningstar Analyst Rating of Silver.

The team here is anchored by longtime manager Dan Fuss, but this is far from a one-man show. Loomis Sayles veterans Elaine Stokes and Matt Eagan joined as portfolio managers in 2007, and Brian Kennedy, who had served as a credit strategist on the team, joined in mid-2016. The four are supported by an experienced analyst corps and a team dedicated to macroeconomic analysis.

At the core of the fund’s appeal is its knack for uncovering opportunities in beaten-down corporates--and even the occasional troubled sovereign--during periods of credit market stress. True to form, the team took advantage of weakness in the high-yield market starting in mid-2014 to bulk up its stake in junk-rated corporates, adding both to troubled energy companies as well as names such as HCA that sold off with the broader market; that positioning paid off as credit markets came roaring back in 2016 and early 2017. Such moves have helped the fund to a 6.4% 10-year annualized gain through March 2017 that tops roughly 80% of its distinct peers.

These strong returns have come with a hefty dose of risk. Although the fund’s allocation to common stock (primarily blue-chip, dividend-paying names) came down sharply from a peak of more than 20% in November 2015 to 7% as of February 2017, it is still notable in a category where two thirds of its competitors hold little or no exposure to equities. That stake, taken together with the fund’s taste for junk bonds (34%) and hefty allocation to non-U.S.-dollar currencies (22%), can make for a bumpy ride. Still, for those comfortable with the fund's considerable risk--and the highest five-year correlation to equities in the group--it remains a strong choice.

Process Pillar: Positive | Sarah Bush 04/04/2017 
This strategy should look familiar to fans of Loomis Sayles Bond. The fund's managers employ a value-driven, credit-intensive approach and are always on the lookout for securities and currencies they believe are undervalued. Here, however, the team has even more flexibility than at the fund's intrepid sibling: It faces no limit on its ability to invest in below-investment-grade and non-U.S.-dollar securities, and it can stash as much as 35% of assets in equities. From 2011 through January 2017, for example, the team ran the fund with a double-digit stake in common stock, favoring companies with a history of growing dividends and strong competitive positions. That said, the team is cognizant of the risks it is taking: Under Jae Park, the firm has significantly built out its tools and staff dedicated to risk management and these are integrated into the day-to-day management of the fund.

Not surprisingly, there's a strong contrarian bent at work here. For example, the fund built a significant stake in troubled Irish sovereign debt in late 2010, a position that rallied sharply in 2012. In late 2014 and the first half of 2015, the fund added aggressively to its stake in high yield against the backdrop of troubles in that market. Such level-headedness when credit markets swoon has helped the fund to an impressive record and supports a Positive Process Pillar rating.

This aggressive fund looked somewhat circumspect as of February 2017, with management citing tight valuations, geopolitical risk, and uncertainty regarding U.S. fiscal and trade policies. The fund featured a nearly 20% stake in a mix of cash and short-term U.S. Treasuries, up from 11% a year earlier. The team had also sharply trimmed the fund’s stake in common and preferred stock to 7%, down from a peak of more than 20% in mid-2015. That included allocations to Bristol-Myers Squibb BMY (4.5%) and IntelINTC (1.8%); convertibles accounted for another 7% of assets, including 1.6% in an equity-sensitive Intel convertible. The decline in the fund’s stake in common stock is notable, as is as the reduction of its once-concentrated position in Intel, which topped 8% in combined common stock and convertible exposure in late 2015. Still the fund’s historically large and concentrated allocation to equities stands out in a category where two thirds of competitors hold very little or no stock.

The fund still has plenty of firepower. The team remains bullish on the prospects for high-yield and stashed roughly one third of the portfolio in these names, including a smattering of energy-related names. The fund also featured a 22% exposure to non-U.S. dollar currencies, including the Canadian dollar (4.6%) and the Mexican peso (4.4%). The latter suffered sharp losses during 2015 and 2016 but had rebounded some in the opening months of 2017.

Performance Pillar: Positive | Sarah Bush 04/04/2017 
The team’s knack for uncovering value in bond market sell-offs is reflected in the fund’s strong long-term returns and supports its Positive Performance Pillar rating. Big wins for the fund include battered corporates such as Ford F coming out of the credit crisis and a good call on Irish sovereign debt built at the height of that country’s troubles in 2010. Meanwhile the fund’s sizable allocation to common stock since 2011 has helped to boost returns, especially in equity-friendly markets including 2013 and 2014. And, as high-yield bond markets came roaring back in 2016, the fund’s large stake in junk bonds helped drive returns; energy and metals and mining names performed particularly well.

That said, this fund carries considerable risk. Indeed, as of March 2017, the fund owns the highest 10-year standard deviation in the group and the category’s highest five-year correlation to the S&P 500. It is particularly vulnerable to losses in weak credit markets. Its credit-sensitive portfolio shed 23% in 2008, for example, landing it behind 90% of its peers. More recently, it fell 11.9% between September 2014 and February 2016, one of the worst showings in its category. Troubles in the fund’s non-U.S.-dollar currency stake, as well as losses in its high-yield, convertibles, and equity positions, all contributed to that slide.

People Pillar: Positive | Sarah Bush 04/04/2017 
Bond market legend Dan Fuss, who pioneered the fund's benchmark-agnostic approach, remains active at the helm here. He is joined by comanagers Matthew Eagan and Elaine Stokes, both Loomis Sayles veterans who have been portfolio managers of the fund since 2007. Brian Kennedy, a two-decade veteran of the firm, was named as a fourth comanager in mid-2016.

Under CIO Jae Park, Loomis Sayles has also invested significantly in the resources backing this group, including the expansion of the firm's risk-management, credit, securitized-asset, and macroeconomic research capabilities. Park has also established a committee structure to help fuel the fixed-income teams' macroeconomic views, asset allocation, and yield-curve positioning. Working together with the portfolio managers, senior-level strategists assigned to each fund share responsibility for funneling investment ideas into the portfolio. This group includes emerging-markets strategists Brian Hess, who joined the group from Brandywine Global Investment Management; corporate strategist John Devoy, who brings two decades of investment experience to the role; and convertibles strategist Diana Monteith, a Loomis Sayles veteran who also oversees the team’s equity investments.

The management team’s significant experience and the firm’s investment in the resources backing it support a Positive People Pillar rating.

Parent Pillar: Neutral | 03/27/2017 
Paris-based Natixis Global Asset Management is the parent to a number of different asset managers globally, including Natixis AM in France and Loomis Sayles and Harris Associates in the United States. These affiliates have a large degree of autonomy both in operational terms and in terms of their investment philosophy.

The quality of investment culture varies significantly from one subsidiary to another, supporting a Neutral Parent rating. The results of the teams at Loomis Sayles and Harris Associates, manager for the U.S.' Oakmark funds, for example, are excellent, communications with investors are of high quality, and fund launches have been minimal. The results obtained by Natixis AM are more mixed, and its teams less stable. Natixis AM has also been opportunistic in launching formula-based funds, which are often poorly understood by investors and currently subject to scrutiny by the French regulator, the AMF. We appreciate that NGAM’s latest acquisition, DNCA, has begun improving its funds’ fee structures since joining the fleet. While we don’t believe investors have reason to panic over the recent executive changes, including the appointment of a new CEO at Natixis AM, a new CEO for North America, and the replacement of NGAM’s global head, we continue to monitor the firm for any potential changes in its strategic direction or its relationship with affiliates.

Price Pillar: Neutral | Sarah Bush 04/04/2017 
Fees on the fund’s Y shares, which account for just under half of assets, rank as just average relative to similarly distributed institutional shares. As a result, we are downgrading the fund’s Price Pillar rating to Neutral from Positive. At 96 basis points, expenses on the fund’s A shares are below average relative to the competition. Fees on all share classes increased by 1 to 2 basis points in 2016 against the backdrop of continued outflows.

 

Sarah Bush is a senior analyst with Morningstar.

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