FPA New Income: A Safe-Haven From Bond-Market Sell-Offs

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FPA New Income has been a bond market bear, lagging its average peer and struggling to meet a goal of surpassing the Consumer Price Index plus 100 basis points per year over the past 10 years. That's a byproduct of its low-risk style, though, and the fund's long-term record is good when volatility is taken into account: Its long-term Sharpe ratios rank near the top of the non-traditional-bond Morningstar Category. Ultimately, the fund is best viewed as a safe haven from bond market sell-offs rather than a source for upside during rallies. With a well-developed process, a good management team, and a history of long-term success, the fund earns a Morningstar Analyst Rating of Bronze.

The fund burnished that profile at the start of June 2016 with an expense cut to 0.49% from 0.58% (at least until May 2017, when FPA will revisit the decision). Lead manager Tom Atteberry says the team's goal is to keep from succumbing to pressure to become more aggressive to keep up in a drastically low-yield market. FPA also changed the fund's parameters to permit holding a minimum of 75% of its assets in securities rated at least single A in its high-quality sleeve, a change from AA-. Atteberry and comanager Abhijeet Patwardhan argue that the risk profile of A rated asset-backed tranches has proved nearly even with AAs, supporting the choice to lump them in with higher-quality fare.

Atteberry has led this fund since 2010 after comanaging the portfolio for several years. His team was dealt a setback in early 2015, losing a corporate credit specialist hired in 2013. The firm has since promoted analyst Patwardhan to director of research and named him a comanager here in November 2015, and it is still adding to the team.

Although Atteberry and his team are impressive, it is still a relatively small crew tasked with covering a big market that, after its next analyst is hired, will have three of six main contributors with relatively short tenures at FPA. That's a situation worth monitoring, but for stability and the benefits of a cautious and thorough style, the fund is likely to remain an attractive option.

Process Pillar: Positive | Eric Jacobson 08/23/2016 The fund is technically tied to the Barclays U.S. Aggregate Bond Index but instead attempts to earn positive returns exceeding the Consumer Price Index by 100 basis points over five-year periods and positive returns over 12-month rolling periods.

That focus on positive absolute returns is part of the reason this fund is in the non-traditional-bond category. Its duration is actively managed but has been very short (less than two years) since 2002, and skipper Tom Atteberry has noted that intermediate-bond yields would have to rise significantly for him to extend duration much past this level. He targets a range of 75% to 100% in high-quality holdings, including cash and U.S. Treasuries and highly rated mortgage-backed, commercial mortgage-backed, and asset-backed securities. The remainder of the portfolio can include more-credit-sensitive sectors, including high-yield bonds and lower-quality securitized bond structures.

Despite its conservative bent, the fund does look for opportunities in areas that have unique sets of risks. Recent examples include loans to mortgage servicers that are purchasing and working out distressed mortgage pools, and interest-only bonds structured from pools of GNMA project-loan IOs. High-yield corporates make up 10% of assets. Combined with robust issue-by-issue research, those features support a Positive Process rating.

The majority of the fund's holdings are very short-term. As of June 2016, the fund carried an effective maturity of 1.8 years and roughly 80% of assets in securitized fare. Its biggest shift in recent years has been a ramping up of ABS to 43% of total assets as of June 2016, from around 13% in 2013. That includes bonds backed by auto loans (including subprime loans), wireless towers, and shipping and storage containers. Another 20% is in nonperforming loans, relocation bonds, and mortgage-backed bonds, including Ginnie Mae interest-only project-loan CMOs with prepayment lockouts, which Atteberry argues carry little refinance risk or interest-rate sensitivity. Other securitized holdings include mortgage pass-throughs (4.5%), CMBS (6%), and stripped CMBS (11%).

Atteberry has maintained a position in high-yield bonds since early 2013 after avoiding the space for much of the past 10 years, favoring short-term, callable high-yield names, and recently added two high-yield analysts to help navigate this space. The fund did have trouble with some of its energy holdings in 2015, but they constituted a relatively small allocation in the portfolio, and the team has taken down its overall high-yield allocation--to roughly 7%--because it was concerned with the sector's increasingly tight valuations and deteriorating fundamentals.

Performance Pillar: Positive | Eric Jacobson 08/23/2016 The fund's record is best assessed versus its own goals of avoiding losses and beating the Consumer Price Index by 100 basis points over five-year cycles, and it has scored 30 consecutive years of positive returns. The fund's short duration helped shield it during the 2013 taper tantrum, and a shift toward cash and high-quality bonds helped the fund return 4.3% in 2008 while many of its peers posted losses.

This positioning has left it behind during the past decade's bond rally on an absolute basis. The fund lags most of its distinct non-traditional-bond category peers on a trailing 10-year basis and would place in the bottom half and bottom quartile of the short-term and intermediate-term bond groups, respectively. Things turned out relatively well in 2015, though, as many funds across categories were buffeted by both interest-rate and credit sell-offs. The fund's overall conservatism helped keep it above water for the year, placing in the category's best third.

The fund's Positive Performance rating is based on its volatility-adjusted track record, and its returns were among the least volatile across the nontraditional, intermediate-term, and short-term bond categories over the trailing 10 years. That helped it to a topnotch 10-year Sharpe ratio that bested the vast majority of its non-traditional-bond peers as well as those in the short- and intermediate-term bond categories.

People Pillar: Positive | Eric Jacobson 08/23/2016 Tom Atteberry joined FPA in 1997 and has led this fund since 2010 after comanaging it with Bob Rodriguez since 2004. Rodriguez remains a strategic advisor.

Atteberry's team had a setback in early 2015 with the resignation of short-tenured head of corporate credit Melinda Newman, who had been a potential successor. The firm has since taken steps to compensate. Analyst Abhijeet Patwardhan was promoted to director of research, was later added as comanager in November 2015, and is as a potential successor to Atteberry. The team had also brought in Joseph Choi in 2014, hired Prakash Gopinath in 2015, is supported by veteran mortgage specialist Julian Mann, and plans to hire another analyst in 2016.

Manager ownership is strong here (Patwardhan has upped his holdings above $500,000 since his appointment), and we have long considered Atteberry and Rodriguez--a three time Morningstar Fund Manager of the Year--among the industry's best. We harbored some concern about the loss of Newman, but the fund has a history of focusing on areas with which it has sufficient expertise and research resources, helping to underpin its Positive People rating.

Parent Pillar: Positive | 07/09/2014 FPA has changed but remains a stalwart steward. The boutique, long identified with its vehement and voluble managing partner Bob Rodriguez, has evolved since he took a one-year sabbatical in 2010. It has lost veterans, including one of Rodriguez's successors at FPA Capital, Rikard Ekstrand, and FPA Perennial comanager, Steven Geist. More than half of the firm's almost 30 investment personnel have joined in the past four years, many of them to help Steven Romick at FPA Crescent, where assets have more than tripled to $18 billion since 2010. The firm, which had $30 billion in assets as of mid-2014, even launched international and global value strategies in 2011 and 2013.

There are cultural constants, though. FPA is a firm run by investors for investors. Besides Rodriguez and Romick, seasoned hands, including FPA Capital’s Dennis Bryan and FPA New Income’s Tom Atteberry, remain, and they invest in their funds. FPA pays managers based on long-term performance and other factors, such as succession planning, to ensure managers think beyond their tenures. The firm also charges decent fees, scorns trends, keeps its nose clean, and communicates clearly with its fund owners.

Asset size could make it harder for FPA Crescent to repeat its incredible record, but the firm’s focus on achieving good absolute, rather than relative, long-term returns via high-conviction, bottom-up strategies hasn’t wavered.

Price Pillar: Positive | Eric Jacobson 08/23/2016 FPA took the fund's expenses to 0.49% in mid-2016, down from 0.58%. (At least until May 2017, when FPA will revisit the decision.) At 58 basis points, the fund's expenses ranked as low relative to those of similarly distributed non-traditional-bond funds, and 0.49% is an even better bargain. Either price is reasonable when compared with short- and intermediate-term bond offerings. Shareholders who redeem in less than 90 days from purchase face a 2.00% redemption fee.