This Aggressive Bond Fund Is a Gem

The following is our latest Fund Analyst Report for Loomis Sayles Core Plus Bond NEFRX. 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 large asset-allocation team, solid underlying managers, and low fees solidify T. Rowe Price Retirement Balanced's Morningstar Analyst Rating of Silver.

This fund served as the landing point in the firm's Retirement target-date series from 2002 until 2004, when the glide path stopped derisking at 40% in equities 10 years past retirement. In 2004, the firm revisited the glide path and decided to continue trimming equities until 30 years past retirement; at that point, the stock weighting levels off at 20%. As a result, this fund was eventually decoupled from the series.

Loomis Sayles Core Plus Bond benefits from an experienced team and a thoughtful, if at times aggressive, approach. Its strengths support a Morningstar Analyst Rating of Gold for the fund's cheapest share classes, while its most expensive share class earns a Bronze.

A veteran and well-resourced management team--bolstered by firm CIO Jae Park's efforts to centralize and leverage research across the firm--is key to the fund's appeal. Peter Palfrey and Rick Raczkowski count more than two decades managing this fund; two senior-level strategists and a nearly 50-analyst-strong credit staff support the effort.

This depth is important given that the fund's flexibility to invest in high-yield (up to 20% of the portfolio) and emerging-markets bonds, as well as non-U.S.-dollar currencies (up to 10%) can make for a potent mix. The associated risks were on display in 2015, when the fund's Y shares suffered a worst-decile 3.9% loss among distinct intermediate core-plus Morningstar Category offerings as energy sector and commodity-sensitive currency exposures suffered. A sizable Treasury Inflation-Protected Securities stake failed to offset those risks as inflation expectations stagnated.

For the most part, though, the team has put its flexibility to good use. The fund sidestepped significant trouble in both 2008's credit crisis and 2011's turbulent markets, for example, thanks to tweaks to its risk profile and currency positioning. It also turned in topnotch returns in the credit-friendly markets that persisted for much of the past decade, including a nice recovery in 2016 and into 2017. In 2016 and 2017, the fund benefited from a sizable corporate stake (including commodity-sensitive names) for most of the period and from well-timed adjustments to duration and yield-curve positioning. In 2018 and into 2019, the team once again turned conservative and by September 2019, the portfolio was dominated by a roughly 60% stake in U.S. government-backed debt, including agency mortgages, and cash; high yield and bank loans (6% combined) stood at a postcrisis low.

Process | High | by Sarah Bush Nov. 6, 2019 Thanks to its wide latitude to venture beyond its Bloomberg Barclays U.S. Aggregate Bond benchmark, this fund moved to the newly launched intermediate core-plus bond Morningstar Category in May 2019, where it remains a relatively aggressive option. 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). It can also allocate up to 20% in high yield and up to 10% in nondollar exposures.

The managers first assess the stage of the current market cycle--expansion, downturn, credit repair, or recovery--to inform the fund's strategic positioning. As of fall 2019, for example, they argued that the U.S. was in the late stages of an economic expansion. That, taken together with tight valuations, especially in high yield, supported a corporate allocation that was near the low end of the fund's historic range.

The team has been nimble with respect to its sector, macro, and currency weightings and has mostly put its flexibility to good use. This, together with the strength of the firm's credit-research effort and quantitative tools, supports a Process Pillar rating of High. However, as a rough 2015 demonstrates, at-times hefty doses of credit, currency risk, and emerging-markets debt can leave the fund vulnerable to losses.

After running with a heavy tilt to credit for much of the post-financial-crisis era, this portfolio started looked decidedly more circumspect in 2017, positioning that remained in place in 2018 and into 2019. As of September 2019, the fund featured a 24% allocation to investment-grade credit, a modest underweighting relative to its Bloomberg Barclays U.S. Aggregate Bond Index. The team continued to hold an out-of-benchmark allocation to high-yield bonds and bank loans but had slashed that combined stake to 6%, down from 20% as recently as June 2016. Meanwhile, roughly 60% of the portfolio sat in a mix of nominal U.S. Treasuries and TIPS (25% combined), agency mortgage-backed securities (33%), and cash (3%).

The fund has long held a meaningful allocation to emerging-markets debt, including non-U.S.-dollar-denominated fare, but that position also stood at historic lows. Emerging-markets corporates and sovereigns stood at 10% as of September 2019, down from 13% a year earlier and as high as 20% in late 2014. The fund's non-U.S. dollar stake was also near the low end of its historic range at 2%, a position dominated by exposure to the Mexican peso.

The fund's 6.2-year duration was just a touch longer than the index's, but the team argued that its empirical duration, which takes into account how non-Treasury sectors react to changes in bond yields, suggested that it was less rate-sensitive overall than its bogy.

People | High | by Sarah Bush Nov. 6, 2019 This team has carved its own niche in the shadow of company luminary Dan Fuss and his team, who run Loomis Sayles Bond LSBRX. Peter Palfrey began managing this fund alongside former manager Cathy Bunting in 1996, and Rick Raczkowski came on board when Bunting retired in 1999. At the time, they worked for Back Bay Advisors, a Loomis Sayles affiliate; the firms merged in 2001.

The merger coincided with a rough patch for the fund in 2001 and 2002, thanks to some missteps in the telecom sector. Around that time, Palfrey and Raczkowski revamped the fund's strategy to depend less on corporate credit and to reflect a more macro-oriented approach.

Key to their success in implementing a more diversified, top-down approach has been the build-out of Loomis Sayles' fixed-income resources undertaken by firm CIO Jae Park. Since joining the firm in 2002, Park has hired teams devoted to securitized and quant research, 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. In addition, the pair works closely with two dedicated strategists focused on the mortgage and credit sectors and draws on the research of the firm's experienced group of close to 50 credit analysts.

Parent | Average | by Mara Dobrescu, CFA Feb. 13, 2019 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 head count 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.

Performance This fund's at-times aggressive approach shows in its performance profile. It makes tactical use of foreign currencies and often loads up on junk-rated fare and emerging-markets debt, all tools that can amp up losses in rocky markets. In 2015, for example, the fund's Y shares lost 3.9%, one of the worst showings among its intermediate core-plus bond Morningstar Category distinct peers as exposure to energy-related corporates, commodity-sensitive currencies, and TIPS hurt.

Over the long haul, however, the team has generally put its tools to good use. After navigating 2008 with skill, it made a timely shift back into the battered corporate sector, fueling strong returns in 2010 and 2011. Its managers also dodged trouble in 2011, thanks to a decision to sell corporates and add long U.S. Treasuries before once again turning bullish on credit and European sovereign debt, which helped the fund flourish in 2012. Meanwhile, after struggling in 2015, the fund came roaring back in 2016 and 2017 as many of its positions rebounded with stabilizing commodity prices. Although the fund’s relatively conservatively positioned portfolio turned in middling showings in 2018 and through the first nine months of 2019, its 5.3% annualized 15-year gain through September 2019 still topped more than 80% of its peers.

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 Morningstar Category's middle quintile. That's not great, but 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 still be able to deliver positive alpha relative to the category benchmark index, explaining its Morningstar Analyst Rating of Gold.