Sun, 29 Sep 2013
MetWest Total Return Bond has run ahead of its peers this year, with help from its nonagency mortgages and utilities exposure, says comanager Laird Landmann.
Michelle Canavan: Hi. I'm Michelle Canavan, a mutual fund analyst for Morningstar. I am here today with Laird Landmann, co-director of fixed income for MetWest/TCW.
Thanks for joining us today, Laird.
Laird Landmann: Thank you, Michelle. It's wonderful to be here.
Canavan: To get us started, it's been a volatile couple of months in the fixed-income markets. It would be great just to get your thoughts and see if you can put that turbulence into a little bit of context.
Landmann: Sure. This has been coming for quite a while. Clearly Federal Reserve policy has been one that has artificially influenced investors to bring interest rates much lower than they normally should have been. It's likely that this was justified to try to get employment gains in the economy. I think as the Fed has realized that the employment gains aren't necessarily following just from quantitative easing and certainly the wage gains have been rather poor, they've backed away from these policies. As they continue to back away from them, we expect that interest rates will continue to be volatile and biased higher. But long-term investors should be wary as we get into the [3% range] and maybe closer to the [4% range] on 10-year interest rates in the U.S. Some value will begin to accrete to investors who are willing put their toes back into the water or closer to those levels.
Canavan: Your flagship fund, MetWest Total Return Bond, has been shorter-duration relative to the benchmark for the better part of two years now. Now that interest rates have ticked up a little higher, has that changed how you are thinking about the duration positioning of the fund?
Landmann: Normally with our value-based approach, we'd almost immediately begin to add some duration back to the fund, given how short we've been versus our benchmark. This case is somewhat unusual, in that the Fed really artificially pushed rates lower than they naturally would have been, and so we're being a little more patient this time. So as rates approach 3%, I think that's the point where we begin to add back a little bit duration, and I think we'd hope to be close to neutral versus our benchmarks as we guide into the mid- to high 3% range in terms of 10-year interest rates. That gives you a real rate of maybe 1.5% to 2.0% and inflation component within that rate of 1.5% to 2.0%. We think that is where fair value probably resides within the U.S. market.
Canavan: As a value-oriented investment team, [as you see] some of the other volatility in the market, has it created any opportunities outside of the interest-rate environment?
Landmann: Certainly, June and July were an unusual period. Usually, when rates are backing up, investors are reacting to a stronger economy in those situations and you expect that corporate bonds, high-yield bonds, and mortgages that are exposed to credit risk should do well in that type of environment. They did not. We did see that as an environment where we could tactically add some additional positions to the portfolio in those sectors that were of good value. But overall we think that as rates move higher, those sectors will probably continue to outperform, and the likely course of action is to be contrarian and shed as prices go up, sell those lock-in profits, and make the fund less risky over time toward those sectors.
Canavan: The fund's relative performance this year in 2013 has been strong compared with the benchmark and its intermediate-term bond peers. Can you talk about what have been some of the main contributors to the outperformance?
Landmann: Certainly, a very patient approach toward duration. As you mentioned, we've been short duration for a long time. We think about duration in a risk/return type of context; not necessarily in a forecasting sort of context. We didn't see the risk/return of U.S. rates with 10-year Treasuries below 2% as attractive for a long time. That patient approach is paying off right now for our investors, as well as I think some of our noncorrelated sectors that we've had in the portfolio, particularly a strong allocation in nonagency mortgages. Some of the asset-backed securities have done very well. Some of our credit plays, particularly in the utilities space, have done very well for us. So, we've been very pleased to have a lot of things working well in this period, but that's not unusual for us. As you can see in your Morningstar statistics, our downside capture, when markets are moving down, is generally very favorable for our style.
Canavan: As you mentioned, the nonagency allocation has been an area that you've added value in throughout the years, and there has been some significant changes in the composition of that allocation, though it's still pretty sizable around 16%. Could you talk about some of the changes within the allocations that you've made during the past year or so?
Landmann: We're a value manager and at the end of the day that means to us we look for sectors that are undervalued that have good fundamentals. Clearly, the nonagency sector has fit that model for quite a while. As prices have come up though, the valuations have gotten more and more challenged. However, as we know housing prices around the country continue to appreciate, the fundamentals remain fairly strong. To adjust for this, we've sort of moved away from some of the lower-dollar price, higher-total-return, higher-volatility bonds into some of the lower-risk, sort of slightly-lower-return, but much less volatility in the portfolio. We've been basically rotating the portfolio and taking advantage of the fact the sector will still do well in our opinion, but the fact that valuations are getting stretched at this point.
Canavan: Well, great. Thanks for being here today and sharing your thoughts. We appreciate it.
Landmann: Thank you, Michelle.