This Excellent Core Bond Fund Just Joined an Elite Group

The following is our latest Fund Analyst Report for Baird Aggregate Bond BAGIX. 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.

A cohesive team, proven and deliberative process, and low fees position Baird Aggregate Bond for long-term success, supporting an upgrade of the strategy's Morningstar Analyst Rating to Gold from Silver.

Lead manager and Baird CIO Mary Ellen Stanek heads a veteran team of five portfolio managers that have worked at Baird for nearly two decades. They are supported by five additional portfolio managers, 12 dedicated analysts, and a handful of other tenured players that assist with research and risk management. While this outfit is somewhat smaller than other firms', it sticks to investments that it can research thoroughly.

Stanek and team curate a portfolio of mainly investment-grade corporate credit, securitized debt, and U.S. government bonds--the primary sectors of the Bloomberg Barclays U.S. Aggregate Bond Index benchmark. The team matches the fund's duration to the index's, while avoiding derivatives, leverage, and esoteric fare, and using high yield minimally.

For most of the strategy's life, it has maintained persistent overweightings to corporate and securitized bonds and downplayed U.S. Treasuries, which has given it a slight yield advantage over the benchmark. To balance that additional credit risk, the team emphasizes diversification and position sizing as risk controls. High-conviction bets on benchmark names are kept within 75 basis points of the benchmark's sizing, and industry over- and underweightings are kept within a handful of percentage points. That risk-aware approach prevents the fund from getting thrown off course by any one bet.

The strategy's slight overweighting in credit can cause it to underperform its Treasury-heavy index when credit sells off, but attentive risk management has kept it from major missteps. The fund's low fees also help discourage outsize risk-taking. From its inception in 2000 through January 2019, it returned 5.2%, landing in the intermediate-term bond Morningstar Category's best quartile.

Process Pillar: Positive | Alaina Bompiedi 02/25/2019 Mary Ellen Stanek and her team have plied a straightforward and risk-conscious approach here for nearly two decades. They seek value through sector rotation and security selection among investment-grade corporate bonds, securitized debt, and U.S. Treasuries, while keeping the fund's duration in line with that of its Aggregate Index benchmark. They avoid derivatives, foreign currency, and leverage.

In most markets, the team tries to outrun the benchmark with corporate credit--typically 30%-45% of assets (usually about 15 percentage points higher than the index’s exposure). It attempts to mitigate that credit risk through diversification and position sizing guardrails. All securities in the fund must be investment-grade at the time of purchase, but the team will hold on to downgraded holdings, such as its legacy nonagency mortgages, which were downgraded in the financial crisis. As of December 2018, the strategy held just 0.5% in below-investment-grade debt compared with the intermediate-bond category average of 6%.

All members of the team source, analyze, and secure investments for the portfolio. While the team’s resources may not match the breadth of larger firms, it stays within its circle of competence and has proactively added tools and head count to deepen its research. This straightforward, cohesive process has served investors well, supporting a Positive Process rating.

Compared with the Aggregate Index, this strategy tends to carry an overweighting in corporate credit while downplaying U.S. government bonds. Over the trailing 10 years, corporates and securitized debt, including agency mortgage-backed securities and structured credit sectors, have comprised the majority of the portfolio. As of Dec. 31, 2018, corporate bonds totaled 41%, while securitized debt totaled 34%. Those weightings were within their normal ranges, though tightening credit spreads (beginning in mid-2016) led the team to cut back the strategy’s exposure to credit and increase its stockpiles in more-defensive agency residential MBS (22%) and U.S. Treasuries (22%).

While the strategy’s predilection for corporate bonds imbues it with more credit risk than the benchmark, the team rarely makes bold bets on industries and sectors, let alone individual names. High-conviction corporate names are typically expressed as a 0.50- to 0.75-percentage-point overweighting relative to the index’s sizing, and industry overweightings are kept within a few percentage points. In 2018, the team maintained a 2-percentage-point overweighting in the energy sector versus the index, preferring the stable cash flows of midstream companies and, to a lesser extent, refining. However, the team cut back its exposure to commodity-sensitive exploration and production companies, concerned about volatility in energy prices.

Performance Pillar: Positive | Alaina Bompiedi 02/25/2019 From the strategy's 2000 inception through January 2019, its 5.2% annualized return outpaced its Aggregate Index benchmark by 47 basis points and 75% of its distinct intermediate-bond category peers. On a volatility-adjusted basis, as measured by Sharpe ratio, the strategy's performance outran 85% of its competitors. Those strong long-term results support a Performance rating of Positive.

The strategy’s credit-heavy bias has given it an advantage over the long haul, but it can also be a source of short-term volatility when credit markets dive. During the 2008 financial crisis, the strategy lagged its index and peers even as management dialed back the corporate stake to 30% (still 7 percentage points higher than the Aggregate Index’s exposure), in part owing to weakness in its nonagency mortgage holdings. That year, the fund lost 2.4%, not as severe as some peers but nearly 7 percentage points behind the index's 5.2% gain.

Yet the team’s prudent approach toward diversification, its tendency to stay higher in issuers’ capital structure, and its preference for shorter-dated fare when it ventures down in credit quality, have helped insulate performance through other volatile stretches. During 2018, a challenging year that contained both interest-rate and credit-driven volatility, the strategy’s 0.30% loss was a smidgen higher than the category’s median loss of 0.35%.

People Pillar: Positive | Alaina Bompiedi 02/25/2019 In her capacity as chief investment officer of Baird Advisors, Mary Ellen Stanek has helped align this team's incentives with shareholders' while fostering a tight-knit, collaborative approach. Seasoned leadership supported by an effective team earn a Positive People Pillar rating.

Stanek heads a five-member portfolio management team that collaborates on the firm’s taxable-bond strategies, including Baird Short-Term Bond BSBIX and Baird Core Plus Bond BCOIX. Averaging 35 years of industry experience, the leadership roster has remained consistent since the strategy’s inception. Four additional senior portfolio managers--with credit research, securitized research, and portfolio risk focuses--and 12 dedicated analysts lend support.

The team’s strengths lie in its experienced leadership bench, cohesive culture, and mindfulness about its limitations. This team does not pursue highly credit-sensitive or esoteric investments that would require resources beyond those that currently exist to support the strategies. Stanek has also been proactive in adding resources, making four new hires between 2017 and 2018 and beginning an expansion of the team’s tools and technology.

While many of the senior leaders on this bench are far along in their careers, the team doesn’t foresee immediate changes to its leadership ranks, and mid-level staff is well-positioned to take the reins in the future.

Parent Pillar: Positive | Alaina Bompiedi 03/21/2018 Baird is an employee-owned, financial-services firm that provides investment banking, private wealth advising, and asset-management services. Its asset-management business comprises fixed-income-focused Baird Advisors and Baird Equity Asset Management. Baird Advisors oversees 95% of the firm's mutual fund assets under management, and its leader, Mary Ellen Stanek, also acts as Baird's CIO, bringing the interests of her group to Baird's senior leadership.

Over the past several years, the firm’s assets under management have grown substantively and quickly. Today, Baird’s asset-management group oversees roughly $65 billion, with $50 billion in mutual funds (up from less than $10 billion five years ago). Although rapid growth can sometimes raise concern, Baird has responded by adding to its investment team and technological resources. Further, Baird Advisors increased the minimum size of its separate accounts to $100 million to slow the pace of inflows.

Meanwhile, Baird Advisors has long maintained low fees overall. Its compensation structure also helps mitigate key-person risk, aligns personnel's financial success with the success of the fund lineup, and has resulted in strong manager retention. Baird's equity shelf is modest, but growing: In 2016, the firm added an international and a global fund to its lineup with the acquisition of Chautauqua Capital Management. Overall, the firm earns a Positive Parent rating.

Price Pillar: Positive | Alaina Bompiedi 02/25/2019 About 95% of the fund's assets are held in its Institutional share class, BAGIX, which charges a low fee of 0.30% (excluding additional investment-related costs) that puts it in competition with some index funds. The Retail share class BAGSX charges 0.55%, below many of its no-load competitors. Compelling fees earn a Positive Price Pillar rating.