A Legendary Bond Fund Gets Downgraded

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Loomis Sayles Bond's deep and seasoned team, contrarian strategy, and solid long-term returns count in its favor. That said, modest concerns surrounding the fund's equity stake support a downgrade of its Morningstar Analyst Rating to Silver.

Long known for its founder Dan Fuss' benchmark-agnostic approach to investing, this experienced team doesn't shy away from risk. Over time, sizable allocations to non-U.S.-dollar-denominated bonds and a large corporate stake, including junk-rated fare, have dominated the portfolio. At the same time, the portfolio's typically mid-single-digit common stock stake distinguishes it from the majority of its multisector bond Morningstar Category peers, while concentration in this stake adds idiosyncratic risk. For example, in late 2016 the portfolio's combined position in Intel INTC stock and an equity-sensitive convertible topped 8%. The team eventually sold that name but bought a 3% position in AT&T T common stock in late 2018's volatile markets, part of a 7% allocation to equities at year-end. The team cited that company's generous free cash flows, strong competitive position, and plump yield.

The fund's aggressive and often contrarian approach has translated into a bumpy ride for investors. For example, while the team had turned somewhat cautious on credit as of mid-2014, the strategy still suffered disproportionately in the commodity-led sell-off that started later that year. For the most part, however, the team has used such periods of market stress to its advantage. In late 2014 and 2015, for example, the team quickly added to battered high-yield names, especially in the energy sector, that it thought most likely to survive. That positioning helped the fund to a strong rebound in 2016 and 2017.

Over the long haul, the team's eye for value has helped it to returns that handily beat most of its competitors over the long haul. The fund's 6.2% annualized gain during the trailing 15 years ended February 2019 topped 80% of its distinct peers. For those with the requisite patience, it remains a strong choice.

Process Pillar: Positive | Sarah Bush 03/06/2019 As the flagship in the Loomis Sayles lineup, this fund has built a strong reputation with its corporate-heavy, often-contrarian approach. Manager Dan Fuss and his team enjoy considerable flexibility: They can invest up to 35% of the portfolio in below-investment-grade names and another 20% in stock (with a 10% limit on common stock). The team is active outside the United States as well, with the leeway to hold up to up to 20% of the portfolio in non-U.S. issuers, including non-U.S.-dollar-denominated debt and the occasional troubled sovereign, and no limit on Canadian exposure. While bottom-up credit research plays a significant role, so do the firm's views on broad economic trends.

The team has shown a keen eye for value. In 2009, for example, the fund increased its stake in Ford F debt at a time when many predicted bankruptcy; in late 2011's credit sell-off, it found opportunities in European corporates amid fears of a potential breakup of the eurozone. As high yield sold off in 2014 and 2015, the team added exposure to junk bonds both in and out of the energy sector.

The fund's potent combination of credit, non-U.S. currency, and common stock courts significant risk, as does its willingness to take at-times concentrated positions in individual names. Still, the team's demonstrated success at identifying value over the long haul supports a Positive Process Pillar rating.

Although this fund is one of the more aggressive options in the multisector bond category, its managers have shown a willingness to reduce risk when they are concerned that investors are not getting paid to take it. By mid-2014, for example, the team had built a 16% stake in short-term U.S. Treasuries, citing tight valuations in credit. As high yield suffered losses in the months that followed, the team bought energy-related names such as Chesapeake Energy CHK and other high-yield issuers that also took hits. By February 2016, Treasuries stood at just 1%, and the fund's allocation to high yield had climbed to 28% up from 19% in May 2014.

In 2017, the team had once again turned somewhat cautious, and by December 2018 the portfolio featured a combined 30% stake in cash and short-term Treasuries, although the rest of the portfolio still carried plenty of risk. As markets turned volatile in late 2018, the team added modestly to investment-grade (15% as of December 2018) and high-yield corporates (25%) and equities (7%); the latter position included a newly purchased 3% in AT&T common stock, which the team liked for the company's strong competitive position, generous cash flows, and an attractive dividend yield. A 20% stake in non-U.S.-dollar-denominated debt, including a 5% allocation to the Mexican peso, rounded out the portfolio, along with convertibles (5%) and 23% in cash and short-term Treasuries.

Performance Pillar: Positive | Sarah Bush 03/06/2019 A history of picking through the wreckage of bond market sell-offs to find value has helped the fund to solid long-term returns. Its 6.2% 15-year annualized gain through February 2019 outpaced 80% of its distinct peers in the multisector bond category, supporting a Positive Performance rating. The fund notched big wins with battered corporates coming out of the credit crisis, European banks bought in the depths of 2011's euro crisis, and a stake in Irish government debt added during the worst of that country's troubles. More recently, in the rocky markets of late 2014 into early 2016, the team once again went to work, buying junk bonds, including battered energy names, that had suffered losses in sympathy with the broader market. These positions helped fuel the fund's strong gains in 2016 and 2017.

That said, that contrarian approach can court significant volatility. Its risks were on full display when falling commodity prices started to roil markets in mid-2014. Even as the team took advantage of buying opportunities, the fund's junk-bond stake and large allocation to commodity-sensitive non-U.S.-dollar currencies contributed to a near category-worst 11.6% loss between September 2014 and January 2016. Non-U.S-dollar currencies and junk bonds were once again the culprits as the fund fell 3.7% in 2018's rocky fourth quarter; losses in its equity stake also contributed to the pain.

People Pillar: Positive | Sarah Bush 03/06/2019 Bond market legend Dan Fuss, who pioneered the fund's benchmark-agnostic approach, has run this fund since its 1991 inception and remains as a comanager involved in decisions about broad portfolio positioning. Matthew Eagan and Elaine Stokes, Loomis Sayles veterans, share responsibility with Fuss and are actively involved in the day-to-day management of the portfolio. Brian Kennedy, who previously served as a credit strategist, is the newest member of the portfolio-management team. A 39-person-strong taxable credit analyst corps and dedicated sovereign and macro researchers support the portfolio managers.

Under CIO Jae Park, Loomis Sayles has also invested significantly in the other resources backing this group, including the expansion of the firm's risk-management, securitized asset research, and macroeconomic research capabilities. Park also established a committee structure to help fuel its fixed-income team's macroeconomic views, asset allocation, and yield-curve positioning. Working together with the portfolio managers, senior-level strategists assigned to each fund share responsibility for funneling investment ideas into the portfolio.

The managers' extensive experience and the analyst resources backing them, taken together with strong manager ownership--three of the four comanagers invest more than $1 million here--support a Positive People rating.

Parent Pillar: Neutral | 02/13/2019 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.

Price Pillar: Neutral | Sarah Bush 03/06/2019 At 66 basis points, expenses on the fund's institutional shares (75% of assets), excluding the impact of certain investment-related charges, are slightly cheaper than the norm for similarly distributed multisector bond options. However, the fund's retail share class (20% of assets) is less attractively priced, with fees that are a bit above category norms. Both share classes saw fees increase by 2 basis points in 2016 against the backdrop of ongoing outflows. This uneven profile supports a Price Pillar rating of Neutral.