A Topnotch Bond Fund

The following is our latest Fund Analyst Report for Loomis Sayles Core Plus Bond Y NERYX.

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The experienced team behind Loomis Sayles Core Plus Bond NERYX has successfully balanced the strategy's risks through rigorous analysis and skillful execution. Its strengths support a Morningstar Analyst Rating of Gold for its cheapest share classes and Silver and Bronze for its more expensive share classes. Veteran managers Peter Palfrey and Rick Raczkowski have skillfully steered this offering for more than two decades. They work alongside two recently named comanagers who serve as the team's mortgage specialists. Together, they effectively use the firm's vast resources, which include an experienced and deep credit research corps that counts over 50 analysts. This team's expertise across sectors, combined with a focus on value and balancing risks, are important given the strategy's flexibility to venture beyond the Bloomberg Barclays U.S. Aggregate Bond Index. While allocations to investment-grade corporates, agency mortgages, and U.S. Treasuries serve as the portfolio's foundation, it routinely holds high-yield corporates (up to 20% of the portfolio) and emerging-markets bonds, as well as non-U.S.-dollar currencies (up to 10%). The team often manages the portfolio's duration and select currency exposures to counter the risk of the credit-sensitive positions, but bold calls have caused short-term turbulence in the past. That was the case in 2015, for instance, when the strategy's energy sector and commodity-sensitive currency exposures suffered. For the most part, though, the team has put its flexibility to good use, including during 2020's extreme volatility. In recent years, the team had reduced the portfolio's corporate credit stake in favor of U.S. Treasuries and agency mortgage-backed securities. These moves helped the strategy hold up better than 80% of its distinct competitors during the coronavirus-related sell-off in early 2020. Then when corporate-bond prices reached historically cheap levels, the team reversed course and added to that allocation in subsequent months. Over the trailing 15 years ended September 2020, the I shares' 6% annualized gain was among the best in its intermediate core-plus bond Morningstar Category. Process | High The team's valuation-driven approach has been key to successfully adjusting this flexible-bond strategy's sector and risk exposures over various market environments. Additional support from a strong credit research effort and robust quantitative tools earn the strategy a High Process Pillar rating. This core-plus bond strategy employs a broad investment universe that includes investment-grade corporates, agency mortgages, and U.S. Treasuries, as well as riskier sectors not found in the Aggregate Index, such as high-yield corporates (up to 20%), emerging-markets debt, and up to 10% in nondollar exposures. Its managers employ a top-down approach in determining its sector weightings, yield-curve, and duration positioning (usually staying within two years of the benchmark's duration). They assess the stage of the current market cycle--expansion, downturn, credit repair, or recovery--to inform the portfolio's strategic positioning, respond to changes in valuations, and may adjust duration or currency exposure to counter the risks of the portfolio's credit-sensitive components. The strategy's hefty doses of credit, currency, and emerging-markets risk can cause setbacks at times, but the team has also navigated turbulent market conditions capably, including the global financial crisis in 2008 and the coronavirus-related sell-off in early 2020. People | High The strategy benefits from an experienced and stable portfolio management corps that effectively leverages the firm's deep research teams and dedicated support, earning a High People Pillar rating. Longtime managers Peter Palfrey and Rick Raczkowski have managed this strategy together since 1999. At the time, they worked for Back Bay Advisors, a Loomis Sayles affiliate; the firms merged in 2001. Since then, its leadership team has been stable except for a couple additions in February 2020. Ian Anderson and Barath Sankaran, both mortgage specialists, oversee the strategy's agency MBS sleeve. Palfrey and Raczkowski also work closely with the team's dedicated credit strategist who offers investment ideas and serves as a liaison between the managers and the firm's experienced group of more than 50 credit analysts. Key to this team's success in implementing a diversified, top-down approach has been the build-out of Loomis Sayles' fixed-income resources undertaken by the firm's leadership team. The leadership team hired dedicated securitized and quant research teams, improved the group's risk analytics, and installed a sector-team structure to improve information sharing. Palfrey participates on the firm's U.S. government and yield-curve teams, while Raczkowski sits on the global asset-allocation and investment-grade teams. Parent | Average Paris-based Natixis Investment Managers is the parent to more than 20 asset managers of very different sizes globally, including Ostrum (its largest affiliate) and H2O in Europe and Loomis Sayles and Harris Associates in the United States. These affiliated companies have maintained a large degree of operational autonomy including in their investment philosophy. The quality of investment culture is uneven from one subsidiary to another, resulting in a Neutral Parent Pillar rating overall. 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. France-based affiliate DNCA has also improved its funds' fee structures to some extent since joining the fleet in 2015. On the other hand, the results obtained by Ostrum are more mixed, with a history of fund lineup churn. Since 2018, Ostrum has embarked on a large cost-cutting plan that should significantly reduce both headcount and the number of funds offered to investors. However, it is still too soon to tell whether these changes will produce better outcomes for fund investors. Ultimately, Ostrum still needs to demonstrate its ability to attract and retain talented investment professionals, and we'd also like to see its cost-cutting efforts shared with investors in the form of lower fees across the board. Price It's critical to evaluate expenses, as they come directly out of returns. The share class on this report levies a fee that ranks in its category's second-cheapest quintile. Based on our assessment of the fund's People, Process and Parent pillars in the context of these fees, we think this share class will be able to deliver positive alpha relative to the category benchmark index, explaining its Analyst Rating of Gold. Performance The team's valuation-driven framework has delivered strong long-term results. Over the trailing 15 years ended September 2020, the I shares' 6% annualized gain was among the best in the intermediate core-plus bond category, besting its typical peer by 1.2% (comparing distinct funds). The team has managed to sidestep most challenging markets. For example, it skillfully navigated both 2008's financial crisis and the European sovereign debt crisis in 2011 through timely sector shifts, which limited losses on the downside and helped the strategy benefit as markets recovered. More recently, the team reduced the portfolio's exposure to spread products between 2017 and early 2020, which helped limit losses in the coronavirus-related sell-off in early 2020. Between the stock market's Feb. 20 peak and March 23 trough, the strategy topped 80% of peers despite a 3.6% loss. The team added to corporates as market conditions improved. However, the team's willingness to invest in speculative-grade corporates and non-U.S.-dollar emerging-markets debt has hurt the portfolio at times. When commodity prices plunged in mid-2015, for example, exposure to energy-related corporates and commodity-sensitive currencies suffered, leading to one of the worst showings in the category that year. Despite this setback, those positions helped the strategy outperform when credit rallied in 2016 and 2017. Portfolio Starting in 2017, the team's assessment that the U.S. was in the late stages of an economic expansion prompted it to lower the strategy's credit exposure. Heading into 2020, corporates accounted for 30% of assets (including 4% in high yield and bank loans) down from 42% in 2016, while the portfolio's securitized credit stake (mainly asset-backed securities and commercial MBS) had been cut to 4% from closer to 10%, and its emerging-markets stake cut roughly in half to 6%. At the same time, the agency MBS stake gradually rose 17 percentage points to 29% of assets. The team also modestly lengthened the portfolio's duration in February to hedge against its growing credit concerns. This defensive posture helped the strategy hold up better than most during the coronavirus-related sell-off in late-February and March and positioned it to take advantage of historically attractive corporate-bond yields. The managers added blue-chip investment-grade and select high-yield issues following the Fed's supportive actions, bringing the corporate total back up to 40% as of September 2020, including 7% high yield. The portfolio's duration ended the third quarter of 2020 about 0.6 years longer than its benchmark's at 6.7 years. The team has remained circumspect toward emerging-markets debt, though. Its local-currency stake (mainly Mexico) remained near historic lows at just 2% off assets.