Q: What is the history of the fund?
The fund began in 2002. In early 2012, Wellington Management took over the portfolio management responsibilities from Hartford Investment Management Company. Since then, we have maintained a consistent theme in the portfolio.
Investment grade (IG) securities make up at least 65% of the portfolio, across government securities, corporate securities, mortgage securities, and asset-backed securities, and include foreign IG opportunities. Before Wellington took over, the fund regularly allocated to bank loans, and we have continued to do so. The fund is involved in a number of different sectors; allocation is based on what is attractive in the marketplace.
Our peers in the short duration area range from high to low quality. We are in the middle, maintaining a relatively high quality portfolio mostly dependent on income. A lot of portfolios in this area dip down in credit quality and go into the high yield market. We do that as well, but rely primarily on our allocation to bank loans. Any holdings in below-investment-grade typically remain just below IG. Even the bank-loan portion of the portfolio is on the higher end in terms of quality ratings and credit fundamentals.
Q: Would you describe your investment philosophy and process?
Two guiding principles are income and diversification. We believe that income, particularly from high quality sources, can provide consistent returns for the portfolio over time. In addition, diversification across sectors and issuers is needed to reduce risk and the possibility of negative results in the portfolio.
A disciplined four-step process begins with our broad, top-down strategy. Top-down inputs include macroeconomic forecasts, market volatility analysis, and sector specific supply and demand trends. The goal is to determine our sector allocation and duration strategy taking into account what is priced into the market from a structural standpoint, from a credit risk standpoint, and from a macro rate standpoint. Four other Wellington portfolio managers and I meet quarterly as a strategy group, along with sector experts and macroeconomists, to make these broad portfolio-level strategy decisions.
This is combined with bottom-up research proprietary to Wellington Management both in the fixed income, and importantly, the equity areas. That side-by-side thinking benefits our credit research. We examine the credit of underlying issuers, how the individual structure is built, and the prepayments and support systems of each individual credit.
In-house fixed income analysts focus on specific sectors and industries. Their analysis and security recommendations filter through the portfolios based on what the group finds attractive from a top-down strategy. All investors have the opportunity to read and review the analysts’ output, and are welcome to attend open meetings we schedule with both fixed income and equity companies/issuers.
Top-down and bottom-up recommendations guide the third step in our process, portfolio construction. To ensure compliance with what clients have asked us to do, we review each separate client’s guidelines. The portfolio manager has ultimate discretion regarding what goes into the portfolio, but it is built on this process.
The fourth step, which is prevalent throughout the process, is risk control. Risk is monitored overall, and on different levels, including diversification, issuer exposure, liquidity, and measures such as tracking risk or standard deviation. Because any number of regulatory environments could have different impacts, a macro team informs decisions with global, U.S., and regulatory perspectives.
Q: What is your research process and how do you look for opportunities?
Research is our bedrock. Wellington Management’s research team has breadth and depth. Here, fixed income analysts work closely with their equity counterparts, and that collaboration has been ingrained in what we do for a very long time.
Individual credit analysts use proprietary financial models and analysis tools. Fifty-one dedicated fixed income credit analysts cover 50 to 100 credits each, depending on the sectors they cover. They average 20 years of experience.
Our credit analysts assign industry ratings and outlooks then dig deeper into individual credits. They consider issuers within individual sectors, and are responsible for examining the fundamentals of sector opportunities as well as of individual credits.
Credit analysts talk to companies using a top-down management approach and evaluate credit viability with this macro look along with a fundamental bottom-up view. They build their own models based on cash-flow outlooks and other metrics and continue to keep the models active.
Other analysts focus on the bank loan segment and may work with a team of portfolio managers to pick individual credits by evaluating underlying covenants and asset classes. Analysts internally share their research with all investors at various periodic meetings and via our internally developed platform for sharing research, Investor Launch Pad (ILP).
We consider selling securities when we do not like their credit or structure, or to be ahead of the credit curve on something. For example, six months to a year ago we were heavily involved in the energy sector. As the area became more volatile, we reduced exposure and currently remain at the lower end of our exposure on the energy side.
One of the fund’s larger overweights has been financials, both U.S. and non-U.S. issuers. Throughout the financial crisis the banking sector was extremely volatile. The financial markets were undergoing a lot of change, driven in part by the regulatory environment. We looked at what that meant for individual issuers and ongoing funding.
As the financial crisis settled, opportunities to invest in the sector and in individual issuers became apparent. Previously under-regulated, the financial sector is now overregulated, which forced companies to improve liquidity and trim down debt.
Banks no longer rely on short-term debt as much, and have built up their own funding and deposits. Early on we identified — and have stuck with — holdings such as Bank of America Corp, JPMorgan Chase & Co., Goldman Sachs Group Inc, and Morgan Stanley. (Holdings information as of 11/30/2015) These were some of the larger issuers in this area and have done well. They transformed their balance sheets and the way they fund differs greatly from several years ago.
Holdings like these match what we try to build in the portfolio. On a risk adjusted basis they are fairly priced, and provide attractive income for how they are rated and with large and frequent issuers the sector also provides a good source of liquidity.
Q: How do you implement your portfolio construction process?
Our process takes top-down and bottom-up recommendations, with analysts identifying attractive sectors and the individual issuers and securities within them. We start with these building blocks and filter through the bigger picture down to what is available and what we find attractive — income opportunities with liquidity and relative value. This ultimately dictates what we buy.
The portfolio has over 500 holdings with about 400 issuers. A typical position size is somewhere between 25 basis points and 1%, though some of the larger holdings may be more in the range of 2 to 2.5%. Currently, the largest individual holdings are under 2% and at least 65% of holdings are investment grade securities.
Officially our benchmark is Barclays Capital U.S. 1-3 Year Government/Credit Bond Index. However, it is a guide and does not dictate the portfolio or allocations. Though we certainly remain aware of the larger issuers in the benchmark, we are comfortable being overweight or underweight individual credits when there is a strong case for inclusion in the portfolio.
Broad, multi-sector fixed income portfolios like ours end up with a higher number of issuers because each component of the portfolio needs diversification within it. Since we invest across the spectrum, below investment-grade securities tend to be smaller allocations than investment grade or similarly structured securities we hold.
Our view on duration is incorporated into the management of the portfolio. We are not duration neutral and can vary the duration of the portfolio subject to the prospectus guideline to maintain a duration of less than 3 years.
Q: How do you define and manage risk?
We incorporate risk management at many levels as we manage the portfolio, and consider interest rate risk, credit risk, overall volatility of the portfolio, liquidity risk, risk to individual issuers or sector holdings, and benchmark risk.
Because these risks change with environments and look different over the course of a portfolio’s lifetime, we must remain aware of them and be flexible. Instead of having one risk department, many teams use a multifaceted, integrated approach to manage risk from different perspectives.
