Fund Spy

A Bold Choice Among Bond Funds

Emory Zink
The following is our latest Fund Analyst Report for AB Income (ACGYX). Morningstar Premium Members have access to full analyst reports such as this for more than 1,000 of the largest and best mutual funds. Not a Premium Member? Gain full access to our analyst reports and advanced tools immediately when you try Morningstar Premium free for 14 days. 

AB Income is an adventurous fund, managed by experienced leadership and supported by expansive resources from across the firm's fixed-income suite. While it has a short record as an open-end fund, its attractive price tag and robust process are encouraging, earning a Morningstar Analyst Rating of Bronze.

The fund's four portfolio managers serve as strategic and sector leaders at the firm, and they have collaborated in various capacities for close to two decades. They are supported by a roster of more than 50 analysts, specializing in credit, securitized debt, economics, and quantitative modeling. Similar to other funds in AB’s fixed-income lineup, this fund benefits from a combination of quantitative models, which enable management to evaluate a broad set of opportunities, and bottom-up fundamental research.

The fund's profile differs significantly from its Bloomberg Barclays U.S. Aggregate Bond Index benchmark and many conservatively positioned intermediate-term bond peers given its global focus and heavier helpings of credit risk. Roughly 65% of holdings are anchored in government securities, both U.S. and foreign, while the remaining 35% of the portfolio is invested across more adventurous out-of-benchmark sectors such as high yield and emerging-markets debt. Currency calls are implemented along the edges of the portfolio. The fund’s process is thorough, but it can court more volatile securities unlike peers with purely investment-grade mandates.

Prior to April 2016, the portfolio was run as a closed-end fund, with looser limits on leverage. As an open-end fund, that leverage range has come down but is still relatively high compared with peers (22% as of May 2018). Leverage had a larger impact on its performance in the past but it is still likely to amplify the fund’s credit risks, which may fuel underperformance during flights to safety. The fund’s performance since assuming its open-end form, from May 2016 through June 2018, benefitted from a risk-on environment, with exposures to high yield and credit-risk transfer securities a particular boon. It returned 3.1% annualized.

Process Pillar: Positive | Emory Zink 07/06/2018 
A broad-based team of sector experts supported by iterative tools results in a repeatable process with the flexibility to scour the global fixed-income landscape for opportunities, and justifies a Positive Process rating.

The fund’s process reflects its broad investment menu and relies on quantitative top-down models and fundamental bottom-up analysis to identify securities, countries, or currencies that appear attractively valued. Quantitative models enable management to evaluate a broad set of opportunities, while sector specialists then focus on the narrowed investment menu, taking into account political or other factors that can’t be reliably modeled quantitatively.

Though benchmarked to the Aggregate Index, the fund is run with a global multisector perspective. Around 65% of holdings are anchored in government securities, both U.S. and foreign, allowing portfolio managers flexibility with the remaining 35%, which they invest across more adventurous sectors such as high-yield credit and credit-risk transfer securities. The portfolio managers actively adjust duration when they have conviction in the direction of rates, but this is typically kept within a year of its index. The fund employs derivatives, and while leverage was used more aggressively in the fund’s prior closed-end iteration, as an open-ended vehicle, it has generally fallen between 10% and 25% (22% as of May 2018).

Managed as a global multisector portfolio with a broad investment menu, this fund’s decision-makers employ its flexibility regularly. Developed global government debt anchors the portfolio and represented 70% of holdings as of May 2018. While the vast majority is dedicated to U.S. securities, non-U.S. exposure was spread across 53 countries and clocked in at 24% of total assets. Emerging-markets debt sat at 9% of the portfolio--an allocation that halved from a year prior given the team’s rockier outlook for the sector--with Brazil (2%), Mexico (1%), and Argentina (1%) the largest country concentrations represented. U.S.-dollar-denominated exposure sat at 103% as of May 2018, with modest currency shorts on the yen (0.8%) and euro (2%).

The team views investment-grade credit as richly valued, and subsequently the portfolio held 4% in the sector and instead allocated 17% to high-yield corporate credit. Additionally, the fund favors more-complex securities than many conservative intermediate-term bond peers, including commercial mortgage-backed securities (8%), asset-backed securities (3%), and collateralized loan obligations (2%). Credit-risk transfer securities, introduced to the marketplace in 2013, were approached tentatively by many funds, but this team evaluated and added them to the portfolio early on, benefiting from a subsequent tightening in spreads; exposure sat at 7% as of May 2018.

Performance Pillar: Neutral | Emory Zink 07/06/2018
From August 1987 to April 2016, this fund was run in closed-end format, with inherently looser limits on leverage. In its current open-end form, that leverage has practically ranged between 10% and 25%, sitting at 22% as of May 2018. The fund’s historical performance generally benefited from the leverage, but it’s unclear how much the change will affect the fund going forward. Its short track record in its current format leads to a Neutral Performance rating.

Given the fund’s penchant for ferreting out opportunities within more-complex structured fare, emerging-markets bonds, and high-yield debt during periods of market stress, it will lag more conservatively positioned intermediate-term bond peers in flights to quality. However, when risk is rewarded, the fund will benefit. For example, since its first full month of performance reporting as an open-end fund (May 2016) through June 2018, the fund returned 3.1%, ahead of 95% of distinct peers on both an absolute and risk-adjusted (as measured by the Sharpe ratio) basis. The fund’s 5.4-year duration was shorter than its Aggregate Index benchmark over the first half of 2018, positioning that aided performance in a period of rising interest rates. The performance of material out-of-index investments--such as credit-risk transfer securities (7%) and high yield (17%)--further fueled results over that period.

People Pillar: Positive | Emory Zink 07/06/2018
Seasoned collaborators and strategy-setters at the helm, in addition to continued investment in fixed-income resources and tools, underpin a Positive People rating.

AB veteran portfolio manager Paul DeNoon, who specializes in emerging markets, and fixed-income chief investment officer Doug Peebles, have collaborated on this portfolio since 2002, when it was a closed-end fund. They were joined by Gershon Distenfeld, a former director of credit research who now serves as co-head of the fixed-income group, in 2006, followed by Matthew Sheridan, a multisector specialist, in 2008. Ashish Shah was briefly named to this fund in early 2017 before departing a year later, but his influence paralleled his tenure, resulting in little disruption to the process.

The fund’s leadership benefits from the breadth and depth of global resources at the firm. AB veteran Darren Williams directs nine economists, whose macro research efforts are shared with an eight-person quantitative-risk group, led by newcomer Bernd Wuebben, that develops models and tools for risk management. Bottom-up security selection is generated by 11 dedicated securitized analysts, led by Mike Canter, and the work of 29 corporate credit analysts, many of whom have long tenures at the firm. Robert Hopper and Susan Hutman, who joined AB in 2013 and 1999, respectively, were recently appointed as co-heads of credit research.

Parent Pillar: Neutral | Emory Zink 05/17/2017 
AXA Financial, AB's majority shareholder, fired CEO Peter Kraus and ousted nine board members in May 2017, abruptly changing AB’s executive leadership. New CEO Seth Bernstein, a J.P. Morgan veteran, and a reconstituted board of directors were handpicked by AXA US, which announced its plan for a 2018 initial public offering on the heels of AB’s leadership shakeup. CEO Bernstein says he's committed to the firm's previous strategy, put in place following poor performance during the 2008 financial crisis. AB has been streamlining operations and emphasizing actively managed strategies.

The firm's future success relies heavily on protecting its fixed-income division, which represents a little over half of assets under management. These funds benefit from a cadre of long-tenured experts, particularly in municipals and global fixed income, and industrious development of in-house tools. In contrast, the firm's equity and multisector offerings have struggled to build a record of attractive performance versus peers and retain bruises from high turnover (which reached 23% firmwide in 2012), expensive price tags, and lack of competitive advantages in an investment landscape dominated by passive offerings. While AXA's changes introduce uncertainty, AB’s core challenges are not new. From here, we'd be concerned by major cost-cutting, key personnel losses, and curbs on independence. For now, we maintain a Neutral Parent Pillar rating.

Price Pillar: Positive | Emory Zink 07/06/2018 
More than 80% of assets are held in the fund’s Advisor shares, which charge 0.52%, a below average fee versus the 0.62% median for no-load intermediate-term bond peers. The fund qualifies for a Positive Price rating.

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Emory Zink does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.