A Bold--Albeit Pricey--Bond Fund

The following is our latest Fund Analyst Report for Janus Henderson Strategic Income HFAIX. 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.

Janus Henderson Strategic Income is managed by a strong pair of managers who have had success utilizing a flexible mandate across the funds it manages. That said, fees are above-average and the team’s decision to carry less risk in the future will likely affect its return profile. All told, the fund remains a solid option and earns a Morningstar Analyst Rating of Bronze.

Lead managers John Pattullo and Jenna Barnard serve as Janus Henderson’s co-heads of strategic fixed income and have managed this strategy since December 2008. They are supported by a large team of analysts and are increasingly leveraging the firm’s resources added from the Janus-Henderson Global merger in 2017. The duo has worked together since 2004.

The managers employ a flexible and unconstrained strategy looking to add value mostly from asset allocation. Unsurprisingly, the structure of the fund is primarily influenced by the managers' assessment of macroeconomic and market factors. These are married with security-specific analysis while incorporating a healthy regard for valuations. They also use derivatives extensively for expressing ideas as well as risk management. Despite the fund’s global mandate, all currencies are hedged back to the U.S. dollar. The team is also not shy to accept duration risk.

The team has a flexible mandate but did make a tweak to the approach in 2017. Historically, the fund exhibited a bias to lower-rated corporate bonds. More recently, the team has indicated that it plans to manage this fund with lower levels of credit risk than in the past. High-yield corporates, which accounted for more than 70% of fund assets in 2013, stood at just 21% as of June 2018. While we do not anticipate additional changes to the investment process, the fund will likely have a more muted performance profile going forward. Indeed, this tamer allocation has been implemented for less than two years, and while a small sample, fund returns have been just average.

Process Pillar: Positive | Zachary Patzik, CFA 09/25/2018

The fund’s structure is primarily influenced by the managers' assessment of macro and market factors. They employ a flexible and unconstrained strategy that can invest across the fixed-income spectrum (credit, gilts, loans, asset-backed securities). That said, this fund’s approach has undergone some change in recent years. The fund has historically exhibited a bias to corporate bonds with high-yield exposure ranging from 20% to 75% and investment-grade corporates from 0% to 70% since the strategy's inception. Since 2017, the team has limited its below-investment-grade fare to less than 35% of the portfolio.

The overall approach, including risk management, is pragmatic and relies heavily on the managers' ability to analyze the economic cycle and position the fund accordingly. Their top-down views and insights on market technicals are married with security-specific analysis. In addition to assessing a company to establish a credit view, they are also valuation-conscious. Furthermore, they use a range of derivatives across the rates and credit markets for expressing ideas, as well as actively managing portfolio duration and credit risk. All currency exposure is hedged back to the U.S. dollar. The team’s concentrated bets can lead to large performance deviations at times, but its effectiveness over the long term across the team’s global charges drives our Positive Process rating.

Tactical shifts in the fund’s allocation can make this fund look different every month. While shifts occur frequently, corporate bonds have remained a focal point. The team has, however, tweaked the fund’s strategy over the prior year ending June 2018, reducing the fund’s exposure to the riskiest bonds. As of June 2018, the fund’s junk-rated stake included high-yield corporate credit (17%) and bank loans (4%), down from a combined 47% of assets prior to the strategy shift in 2017. The reduction in below-investment-grade fare owed to both the strategy shift and the team’s unfavorable view of the broad bank-loan market, primarily because of issuer quality and covenant concerns. Meanwhile, the investment-grade credit stake totaled 35% of fund assets.

With the fund’s overall credit exposure lower, the team added to government bonds. These bonds, primarily issued by the United States, United Kingdom, Australia, and Canada, totaled 31% of fund assets as of June 2018. This stake was 15% of assets a year earlier.

Unlike many bond managers, this team does not shy away from taking duration risk. At nearly 7.0 years, the fund’s duration was higher than the peer average as of June 2018. This figure can shift quickly over a month’s time as the managers utilize derivatives to adjust positions. In fact, the fund’s duration was approximately 3.5 years at the beginning of 2018.

Performance Pillar: Neutral | Zachary Patzik, CFA 09/25/2018

Despite strong absolute returns over the long term relative to peers, the fund’s strategy shifted in mid-2017 and it now takes less credit risk than it did in the past. As a result, the portfolio is likely to produce a tamer return profile that differs from its past record. The fund thus earns a Neutral Performance Pillar rating.

From January 2009 through mid-2017 when Jenna Barnard and John Pattullo managed the fund with more than 35% below-investment-grade issues, the fund generated 10.6% annualized and topped its world bond USD hedged Morningstar Category average peer by 5.3%. The fund fared particularly well in 2009, gaining more than 50% as markets rebounded sharply following the financial crisis. While solid over the long term, the fund was vulnerable to bouts of underperformance. For example, returns suffered during the 2011 euro crisis as the fund trailed its average peer by more than 6 percentage points. It also lagged its average peer when credit sold off from June 2015 through February 2016.

From mid-2017 when the team decided to manage the fund with less credit risk through August 2018, the fund’s returns have been just average relative to peers. While this represents a short period, the fund’s reduced allocation to below-investment-grade debt is likely to result in a more muted profile in the future.

People Pillar: Positive | Zachary Patzik, CFA 09/25/2018

Skilled portfolio managers and a well-staffed research team earn the fund a Positive People rating.

The fund is managed by John Pattullo and Jenna Barnard, co-heads of Janus Henderson’s strategic fixed-income team. Together, they have managed the fund since December 2008, with Pattullo and Barnard joining Henderson in 1997 and 2002, respectively. Pattullo has managed the fund’s U.K. counterpart (Janus Henderson Strategic Bond) since 1999, while Barnard later joined as a comanager in 2004. The pair comanages five other funds.

Pattullo and Barnard are talented fixed-income managers. The solidity of their collaboration dating back to 2004 is in their favor. They have demonstrated an aptitude for analyzing the economic cycle and positioning the portfolio accordingly over time. Furthermore, they also benefit significantly from the input of nine credit managers based in London and Janus Henderson’s experienced pool of 20 credit analysts (though 13 of them have joined the firm in the past five years), who split coverage of both investment-grade and high-yield bonds by sector. The managers are also increasingly leveraging Janus’ resources added from the Janus-Henderson Global merger back in 2017. Last, both managers are personally invested in the fund’s U.K. counterpart, which helps align their interests with those of investors.

Parent Pillar: Neutral | 08/30/2017

In October 2016, Janus Capital Group and Henderson Global Investors announced that they intended to merge. The deal was completed at the end of May 2017, with the new group named Janus Henderson Investors.

The business aims and rationale for combining the two entities were clear. Both firms had been looking to diversify their product ranges and increase their scope of distribution, and this merger achieves those objectives. The combined entity also has greater scale--total assets under management were $345 billion at the end of June 2017--but no long-term fee cuts, which would help the firm better compete in an industry where fees are declining, have been announced. The previous firms' CEOs are co-leaders of the new group, and Enrique Chang, Janus' head of investments, is the overall CIO. This provides some potential for change to the Henderson culture, but Chang had a positive impact on the Janus equity team, and some senior members from the Henderson investment team still have a voice.

There have been personnel departures, but the fact that investment team overlap was relatively limited has been a positive. There are, however, likely to be further changes as the group strategy takes shape, not least in terms of the CEO role, which the board is expected to review in three years. We continue to monitor this situation. Both firms previously earned Neutral Parent ratings, and the combined firm does as well.

Price Pillar: Negative | Zachary Patzik, CFA 09/25/2018

The fund’s fees are higher than the average offering within the world bond USD hedged category. As such, the fund warrants a Negative Price Pillar rating.

The bulk of the fund’s assets are held in the Institutional share class (84%), whose net expense ratio excluding the impact of certain investment-related expenses is 0.75%, 8 basis points higher than the median for similarly distributed funds. The fund’s six other share classes are also priced above their distribution channel medians.

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