Q: What is the history of the fund?

The fund is organized around a multi-asset class strategy that has always included both equities and bonds. It falls within the conservative allocation bucket, which reflects our target audience and investment objectives. Since launching the fund more than 20 years ago, we have added more dynamic management to the portfolio in line with the evolution of the markets and our team.

Q: Would you describe your investment philosophy?

Our target audience consists of conservative, income-oriented clients. The fund has three investment objectives:  a high and consistent level of income, an attractive level of capital appreciation, and lower volatility than the equity market (less than 2/3rds).

More specifically, we seek to generate high and consistent income in excess of 4% net of fees for the institutional shares of the fund. This is set on a rolling 12-month basis because distributions from equities are lumpy; bonds pay out monthly, while equities pay out quarterly. Our most recent 12-month distribution yield is roughly 4.5% net of fees. 

The fund addresses a common problem investors face today. On the fixed-income side, yields are low and rates are likely going to rise in the U.S. On the equity side, valuations are arguably full and perhaps still stretched in the higher-yielding part of the market. This is a challenge that faces all investors today, but particularly conservative income-oriented investors. 

We believe the next five years of investing will look very different than the past five years and will need a different playbook. As a start, we cast a wide net that includes non-traditional sources of income. On the debt side we include high-quality credit, high-yield credit and bank loans, and on the equity side, preferred equities, REITs, energy infrastructure and business development companies. All these have attractive investment attributes that make sense for our portfolio, so long as they are sized appropriately and we are mindful of security selection.

Widening the opportunity set across asset classes offers three benefits. It can generate a higher yield, add more diversity to our yield sources, and importantly, add more interest rate resiliency versus traditional bonds.

Additionally, we dynamically manage the portfolio on multiple levels, and seek to add value through asset allocation and extremely active security selection. Our Income Builder Fund’s home base is a 60/40 division of bonds and equities, though that split can be tilted 15% in either direction. The equity and fixed-income teams work together on the investment committee to extract value in what we describe as asset location (i.e., making an active decision on where to own a company in its capital structure — do we own the bond or the equity based upon the yield, upside potential and volatility attributes?). 

Lastly, we believe it’s very important to not stretch for yield. Although this was rewarded during the last five years, we think going forward it will be penalized. 

Q: What is your investment strategy and process?

Our portfolio management is based on bottom-up fundamental research melded with a top-down macro view of expectations of what will happen in the economy.

The primary goals that we have set are sustainable income over time, capital appreciation, and volatility management, and we use an integrated approach and a range of unique tools to bring these together. 

Two individuals — the CIO of fundamental equity and the global head of corporate credit and  the fixed income cross sector team  — head an investment committee with a number of senior investors that shape the top down framework of the fund. Below them, three primary portfolio managers are responsible for day-to-day security selection and portfolio management. 

For us, it is not just about generating beta with regard to the market. It is about seeking to achieve our three objectives through asset allocation, asset location (where to own a company within its capital structure) and security selection and doing so on an integrated basis (where the fixed income team talks to the equity team and vice versa). The portfolio managers get the best ideas from our analysts in the fixed-income and equity teams, and then weigh those ideas according to how they fit with the objectives of our fund. Due to our integrated process, we can manage a more focused and nimble strategy t and can better avoid unintended concentration risks.

Our strategy typically has between 350–450 issuers in equity and fixed income securities. Many other portfolios in this space hold thousands of issuers, allocate capital to specific sectors from their top-down macro team, and then let their investment group actively manage those particular sectors. They end up with market beta and some security selection.  

Q: Can you provide some examples that highlight your research process and how you look for opportunities?

When investors screen the opportunity set across equities and bonds through the lens of yield, telecommunications and utilities will typically percolate toward the top.

In the telco landscape, we do not own many of the names that often have the highest yields, because they tend to be aligned with the wrong part of the telecommunications market. With people cutting the cord and going wireless, these are companies aligned with the landline, consumer-oriented part of telecommunications.

Despite their very high yields, we do not own these companies on the equity or bond sides. We would rather own an equity aligned with the right part of the telco industry. Not ones with a double-digit yield, but more in the 5% territory. They would also have a lot of growth behind them, have strong balance sheets, and yield sustainability.

We look at equities in both the U.S. and outside it that fit these criteria. Because equities are implicitly lower down in the capital structure, we push up in quality as much as we can in light of this reality.

On the bond side, we will consider companies a touch further out on the risk spectrum. Their balance sheets may not be as pristine, but that we feel they will survive and thrive. Because of the incrementally greater risk, and because these types of equities often do not pay out a dividend, we would prefer bonds over equities in this case.

Within the financial sector, we have favored more of the subordinated aspects of the banking sector on the fixed income side. 

Bank credit is lower than it has historically been, based on average credit quality. This is not because the financial condition of banking institutions has deteriorated but rather due to the backstop of government support being taken away. As a result of the regulatory environment, banks are in better shape than they have been in a long time. 

We anticipate reasonable performance and enhanced yield with regard to not only banks but also insurance companies. Rising rates will help from a net interest margin perspective. The key is to have dedicated global analysts who understand the regulatory environment in the US  as well as globally and can therefore  judge the subordinated aspect and structure of debt relative to the senior nature.

Fixed-income financials also give more protection against mergers and acquisitions. Rarely does a bank face M&A risk, which can be a greater factor in other sectors. 

On the equity side, we favor those financial companies that are positively correlated with rates. It is one of the few sectors where you can find value and rate resiliency. That is one of the the challenges on the equity side. When you look at the high-yielding part of the market, there is a lot more rate risk.

Beyond casting a wide net and assessing opportunities across both bonds and equities on an integrated basis, we also believe it’s very important to not stretch for yield in today’s environment.  On the equity side, we do not fish in the first quintile of yield, as much as we do in in the second quintile. In exchange, we get companies with better balance sheets, lower payout ratios, better earnings growth, and that trade at better valuations.  We are constructive not only on banks and insurance companies, but also remain generally constructive on the health care sector as indiscriminate selling created select buying opportunities in our view. 

On the fixed-income side, one can stretch for yield by pushing down in credit quality and pushing out in duration. On the former, our exposure to lower credit quality—in the CCC space—is very low, less than 2.5%. It has migrated down as the credit cycle aged, and we have become more defensive in our positioning. On the latter, we have the ability to manage duration which we believe is a very important tool with the prospect of rising rates.

Bonds have duration. Although we do not view equities as having true duration, certain sectors of the equity market are sensitive to rates. 

In terms of our outlook, we believe the economic cycle still has legs, and that the U.S. economy will continue to grow at a reasonable rate. We can earn yield and still see some tightening in credit spreads as the cycle continues. Our portfolio will continue to migrate up a bit, buying more investment grade credit since it cheapened this year. In terms of equities, we forecast that we’ll see strong single digit returns in the coming year.

Q: What is your portfolio construction process?

We’ve already discussed our investment process which is dynamic and comprised of top down and bottom-up inputs.  In terms of portfolio construction, we allocate risk according to conviction across the full yield continuum spanning both bonds and equities.  Since our objectives are unique where we seek to achieve “outcomes” that extends beyond just outperforming an index on a total return basis (i.e., high sustainable yield, capital appreciation, and lower volatility), we believe allocating risk relative to an index is not the right way to do it.  

We simply allocate capital to our “best ideas” within the framework of our conservatively tilted investment objectives, not with the framework of an index.  This has served us well as proven by our investment results.

Q: What is your benchmark? How do you diversify the portfolio?

We do not manage to the benchmark per se. It is there as a reference point more than anything. Instead we manage to the key objectives of the strategy: sustainable income, capital appreciation, and less volatility than the equity market. Our metrics of success are whether we have hit these objectives and whether we have done it better than our peers. It makes the relative to index far less relevant, and why we try not to focus on it.

This is a manifestation of outcome-based investing. The objectives are to do much more than just outperform an index on a total return basis. 

In terms of turnover, there are more transaction costs in fixed income than in equity so we are mindful of that in managing the portfolio. Over the past few years, turnover has averaged in the 50% to 55% range annually. 

Our intent is to create diversified portfolios across the major sectors of the market. Currently, the portfolio contains approximately 80 equity securities and 290 fixed-income securities, putting it at the lower end of the spectrum within this conservative category. 

While we do not want oversized bets in any one sector or security, when you diversify with thousands of securities you end up with beta and very little security selection. 

We are not the highest-yielding multi-asset fund within the conservative category. Nor do we strive to be the highest-yielding fund. We want sustainable yield melded together with capital appreciation to deliver what clients are looking for. That’s why the fund’s title is “Income Builder.”

Q: What is your definition of risk? How do you manage it?

At Goldman Sachs Asset Management, we have a culture of risk management that informs how we think about portfolios, both in the fixed-income and the equity sides of the house. Targeting two-thirds or less of the volatility of the S&P 500 Index in our strategy has achieved attractive return within those risk parameters.

The key is understanding the risk embedded in the portfolio relative to the market, the correlation of the investment strategies that are in place, and the impact of security selection and interest rate risk.

We use proprietary risk models to manage the portfolio. An integrated risk model takes into account fixed income and equity. It allows us to understand the correlation of risk within the portfolio, to look at the concentration of both equity and fixed-income names, and the interest rate sensitivity. We can also disaggregate the underlying equity and fixed-income components of the portfolio to provide more granular analysis as needed..