Q: What is the history of the fund?

I have been running the Hartford Strategic Income Fund since 2012, when I took it over from the Hartford Investment Management Team. ?y experience in running multi-sector portfolios dates back to 2000. This fund is managed by Wellington Management, where I am a partner.

The goal of the fund is to obtain high income for its shareholders with good downside protection during negative market events. Since I took over the fund, we have strategically devolved away from investment grade corporate bonds and focused more on high-yield credits and government bonds. While high-yield credits provide high income, government bonds provide downside protection and liquidity during risky events.

Q: What differentiates the fund from its peers?

As part of our diversification philosophy, we have always run the fund with a longer duration profile than our peers. We believe that we can have longer duration because we provide good income through high yield credit.

Another difference is the real focus on incorporating a broad range of high-yielding credit ideas, including corporate, emerging markets sovereign and corporate credit, combined with tolerance for safety through government bonds. As a result, we have more emerging market bonds and less investment grade corporate bonds than our peers.

Q: How would you describe your investment philosophy?

First and foremost, I believe in identifying fundamental value in the securities we buy. We do that through deep research of each investment, driven by the vast research capabilities that we have at Wellington. Ultimately, I believe that securities can fluctuate, but if you identify securities with good fundamental value, you are going to outperform in the long term. 

Second, diversification is a key aspect of our philosophy. I want to have a breadth of different ideas in the portfolio that are uncorrelated to one another because not everything is going to work at any given time, so we don’t want performance to be dependent on any one persistent sector bias. In the long run, we believe that a diversified portfolio provides solid steady return for clients. 

The third aspect is the focus on risk management. I believe that one should always weigh the possible returns versus the risks taken. We analyze risk at the security, sector and portfolio levels to make sure that we take the appropriate risk for the returns that we expect.

Our goal is to provide good total return over a market cycle. Of course, we cannot get protection against every move of the credit markets and we do have a fair amount of credit and interest rate risk in the portfolio. We are willing to take some risk and to experience some market fluctuations but, ultimately, owning securities with good fundamental value wins out. That’s what we aim to unlock.

Q: What is your investment strategy and process?

We have a three-step investment process. The first step is the top-down strategic allocation to the different sectors, including high-yield credit, bank loans, emerging markets, sovereign and local currency debt, government bonds, investment grade corporates, and structured finance securities. We decide which sectors have the best risk-adjusted return potential and we also make a decision on duration.

The second step is security selection, for which I lean on the expertise of the specialists at Wellington. While most of the top-down decisions are made by me and my team, for security selection I rely strongly on a team of specialists, who have worked with me for a long time and who know each area of the market. They do the deep research to pick the securities that we buy in each sector. 

The third step is portfolio construction. At this step, we examine the overall portfolio to see if there are any risks that we were not aware of. We check if we have the credit risk that we expect to have. We see if we are overexposed to housing, financials, or any other types of risks. If we are, then we go back and revisit the first two steps. The third step is key to the risk management process. 

Q: Would you tell us about the main drivers behind your sector allocation?

Two key elements differentiate our sector allocation process. First, we look at the sectors based on their risk-adjusted excess return potential. That means that we analyze them independent of the duration or the interest rate sensitivity of each sector. We aim to understand which sector would generate the best excess returns for the amount of risk that we take. 

Right now bank loans would be a good example. Currently, bank loans have lower yields than high-yield securities, but we actually think that bank loans have better excess return potential. They represent lower risk because they have better protection and lower volatility than high-yield securities. So we have tilted the portfolio towards an allocation to bank loans. 

Another key aspect is working with the specialists, who provide bottom-up views on their sector of expertise. For example, over the last couple of years our structured finance expert, David Burt, held a really bullish view on U.S. housing. As a result, we have had significant allocation to the non-agency mortgage sector. That exposure was driven by his strong belief in the resiliency of the U.S. housing sector.

Our long-term strength is the differentiated approach towards the sectors and the power of the collaboration between me and the specialists. Ultimately, it is the framework of potential returns for the different sectors that drives our sector decisions.

Q: How do you organize your research process?

We have a monthly strategy meeting with all the specialists, where they rate their sectors based on four key aspects: fundamentals, valuations, technical, and tail risk. Each sector is rated on a scale from zero to 10 and that allows us to have common ground for discussion. The process reveals the conviction of the portfolio manager in his or her sector view. 

Then we have discussions to verify and challenge the view and the conviction of the specialist. Why does he or she think that non-agency mortgages are going to outperform high yield or emerging markets? The presence of the other specialists allows us to ask questions from each perspective. The process of working with them each month and seeing how their views evolve in the long run is really powerful. 

I have been working with this group of experts for so long, that I have a very good sense of who has strong conviction, who always likes his or her sector, and I think that long-term partnership is really important. When certain specialists are even mildly bullish on their sector, I know that is a really strong signal, while when others are even neutral on their sector, I know that’s a negative signal because some of them are always bullish. 

That is a key judgment that I have to make. The stable team, the consistent working relationship, and the years of building a shared knowledge, helps me detect the nuances. The collaborative culture, where sharing of information is encouraged and rewarded, as well as the discipline in the regular meetings with a wide variety of people, allow us to stay on top of a complicated and diverse set of securities.

Q: How do you select individual securities?

Ultimately, when you buy a bond almost any bond with credit risk, you are making a loan to a company or government entity. Our goal is to have high confidence that the borrowers we select will pay us back.

At the security level, we ask our credit analysts to rate each security. For example, in the high-yield area, analysts rate the securities based on credit and relative value in four categories – 25% are rated as top performers, 25% as outperformers, 25% as underperformers, and 25% as sell. The analysts behave like investors because they will be tracked based on the performance of their recommendations. 

At the next level, the sector specialists decide their view on the industries they cover. We don’t simply buy the top names from each sector. For example, if we think that home building will outperform retail, I would buy all the top performing home builders as well as some market outperformers, but very few top performers from retail. The final decisions depend on our view of the various industries. 

We don’t buy securities that the analysts rate as underperformers or as “sell,” but we cannot buy everything that they rate as top performers or outperformers. That would simply be too many securities because of the way they are force ranked. So, while the analysts do the credit picking, portfolio construction is done by the specialists based on industry best relative value.

Q: Could you elaborate on your international exposure? 

The fund does not have “global” in its name, because it doesn’t always have a substantial allocation to global bonds. Its exposure to the U.S. market is much larger, but the fund does invest globally when we see value outside of the U.S. 

More often than not, we have a sizeable allocation to global bonds. Right now we have a significant allocation in subordinated European financials, because we see good value in that area. These securities are significantly underrated as the market considers them to be riskier than we believe.

We also buy sovereign government securities in emerging markets. It is a separate decision whether to hedge the position or to take currency protection. Sometimes we hedge and sometimes we don’t, but we take currency risk because we have the currency expertise of Wellington. It is part of the diversification and the breadth of ideas we are looking for. 

Q: How do you construct your portfolio?

We run a highly diversified portfolio, comprised of a lot of different ideas. Diversification extends from the top level, where we diversify between credit and duration, through the various sectors in which we invest, and down to the individual security level, where we are not overly dependent on the performance of any single security. 

The typical position size is less than 1% of the portfolio, often much less than that. We limit our exposure to any issuer to 1%, except for the U.S. government and a few other entities with very low credit risk. At the sector level, there is no hard rule and we do have a tremendous amount of flexibility by our prospectus. 

Having a diverse mix of ideas is one of the tenets of the strategy. Normally, we have more than 200 holdings. This is never going to be a high-yield portfolio or an emerging market debt portfolio; it is always going to have a mix of ideas. No sector has been overwhelmingly dominant in the portfolio over time. 

Q: What is your benchmark and how important is it for managing the portfolio?

The Fund’s benchmark is Barclays Aggregate, however we don’t manage close to the benchmark. Instead, we use an internal benchmark as a rough approximation of the portfolio, which is about one third global government, one third emerging market sovereigns, and one third global high-yield corporates. 

The relevance of the Barclays Aggregate as a benchmark is in giving a broad idea of how much credit risk versus safety you might expect us to have. It is not a good representation of the portfolio itself, but reflects the proportion of risk assets versus safety assets. Overall, we are benchmark aware, but not a benchmark hugger. 

Q: What is your buy and sell discipline? Can you provide some examples?

We don’t have hard stop losses, but when a security is not performing in the way we expect, we would re-underwrite the story, because underwriting each credit is based on a story. 

Given the volatility of the markets, it is not a question of selling something because it is down. I don’t believe that having a stop loss would be smart. But we repeatedly re-underwrite the security when the story changes.

For example, we held a retailer that we expected to be fairly stable. Its new CEO, however, employed a fashion strategy, which did not do well and the security performed poorly. Since the strategy and the cash flow of the company changed, we examined the security again. The main question was not whether to sell the security because it was down, but whether we believed in the strategy after it had clearly changed. 

Q: How do you define and manage risk?

One of the key metrics is excess return volatility and we follow each security and sector we own on a day-to-day basis. The second metric is correlation of portfolio alpha with credit spreads. As credit spreads widen or tighten, I need to know how the strategies in the portfolio respond and how the overall portfolio responds. 

Another risk metric that I use is scenario analysis, so I examine the alpha of the portfolio under various scenarios. In particular, the financial crisis, the Taper Tantrum, and the telecom crisis of 2000 to 2002 scenarios, are important to estimate my potential downside during a similar event. 

We are fairly granular in risk management, because we need to understand how each strategy in the portfolio will perform. For example, if we allocate to bank loans, we need to understand how much volatility this particular allocation introduces, the correlation to credit spreads, as well as the performance of bank loans under the above mentioned scenarios. 

Also, we ask the same questions about the individual specialists doing the security selection. How much credit sensitivity are they adding to the portfolio? Are they defensively positioned? Are they reducing the credit sensitivity? If we want more credit sensitivity, while a specialist decides to position more defensively, we’ll make adjustments.

We have a proprietary risk system that does this ex ante and a key metric that we use is to monitor ex post, or to see how the portfolio is actually behaving. I receive a daily risk report and can make corrections in real time if we identify an issue. 

But the main advantage of Wellington in terms of risk is the tremendous amount of resources, the depth and breadth of knowledge across all the asset classes.