Q: What is the history and goal of the fund?

A: Voya Intermediate Bond Fund was established in 1998. It is the cornerstone of our fixed income funds in the intermediate bond space. As a multi-sector fund, it draws upon our different asset teams to achieve the right balance among the sectors and to get the right securities. It is one of our largest offerings with more than $8 billion in assets and our flagship product in one of the biggest bond fund categories.

The goal is to provide top quartile or better performance with top quartile or better information ratios. So we aim for good risk-adjusted return combined with downside protection. We believe that the fund provides a smooth ride, while still offering attractive performance.

Q: Which areas of the market do you operate in?

A: The fund operates in the taxable bond space, with allocation of at least 80% in investment grade and up to 20% in below investment grade securities. It provides a high-quality offering, managed in a balanced way across all the segments of the taxable bond market. The fund hasn’t really changed in the last five years, but has managed to continuously deliver alpha through different market environments relative to the Bloomberg Barclays Aggregate Index and its peers.

With investments in high-yield corporate, senior bank loans, securitized positions, Treasuries, global sovereign, mortgage-backed, asset-backed securities, an array of corporates and emerging markets bonds, the fund encompasses a broad pallet of different risks with a minimum of 80% in the investment grade rated space.

Q: What core beliefs drive your investment philosophy?

A: Our core belief is that the broadest possible preview informs the highest-quality return stream. We lean towards a team-oriented process and away from a star-manager process. That means that we rely on more than 160 fixed income professionals on our Voya Fixed Income team. We pull upon the insights of all the teams to develop a view of the world. That view leads to informed decisions on the best upside/downside return opportunities.

We believe that the broad array of information provides an advantage, which leads to better sector allocation and to less excessive risk and style bias. Some of our peers have more style bias towards certain sectors, while we have a broad array of teams across multiple sectors. We communicate constantly with those teams to identify the best risk/return potential in the taxable bond market.

We are aware of the risks that we take and the returns we try to generate, so we are in constant coordination with our risk models and our risk team. We need to understand the current positioning, the scenario analysis, the tracking error, and to make sure that our views are consistent with our alpha and risk targets.

Q: Do you consider yourself a relative value investor?

A: Every day we aim to identify better relative value within the bond market. We are willing to shift between different segments, such as mortgages, asset-backed securities, emerging market debt, investment grade credit, high-yield credit or bank loans. We always search for the best value relative to risk. Then we prioritize the allocations to the most attractive segments. Finally, within these allocations, we aim for superior security selection to drive performance. That selection is relative as well. We constantly look for the best securities within the best sectors, while trying to avoid a consistent style bias or risk skew over time.

Q: What are the critical steps of your investment process?

A: It is a three-step process that weds together a top-down and a bottom-up approach. Our process starts with the development of our macro view. All of the sector heads and their teams across corporate, securitized, EM, Treasuries, etc., are part of the dialog, where we develop a global view of the investment landscape. We identify the core themes and the tenets that will drive the markets for the next six month, the next year, and in the long term. So, step one is developing our best possible view of the current state and the future outcomes.

In step two, we develop the asset allocation within the different segments of the benchmark, such as Treasuries, mortgages, corporate, senior bank loan, high yield, and a broad array of securitized bonds, from agency to commercial mortgage-backed securities to consumer ABS. Step two is informed by the macro view for the best risk-adjusted returns at the sector level. We set the sector and risk allocation by assigning weight, risk factors and duration factors to each individual segment of the bond market.

When allocating risk, we view the large duration positions within the bond market as a low information ratio source of return. So, we tend to be modest in any duration skews in the portfolio. We believe that we can add more value by being in the right sectors and securities, because we see little excess return driven from relative interest rate positioning as it represents a low IR source of return.

In step three, the individual sector teams go forth to buy, sell and research what they view as the best opportunities within each component of the bond market. Each team has its own process and analysts to choose the right securities for the specific risk and percentage allocation. So, the third step is the security selection and about 50% of our excess return comes from security selection.

Q: How is the research team organized?

A: Each sector of the bond market has its individual portfolio manager and research team. They are all fortified by our quantitative research team, which has been building macro and quantitative tools for nearly two decades. It provides all the possible data for informing the fundamental research at the macro and micro levels.

At the security selection level, all of the teams have their own research as they are subject matter experts on the different industries and the companies within those industries. Their research process pulls upon our quantitative pool of research. Each of the teams decides what are the best return opportunities within the segment and works with the sector head to develop these views, to do the appropriate research and then to manage the component of the portfolio that’s been allocated to them through the risk process.

That research process iterates constantly. Our research teams are embedded in each sector as opposed to being centralized. We believe that the proximity of research to the portfolio manager and the sector team head, as well as the exchange of information within each sector, is crucial. The dialog across those different segments of the bond market is incredibly important. It is powerful and extracts value through a belief that sharing information in a culture of collaboration is beneficial to our understanding of the world.

For example, our commercial mortgage-backed team gives us greater insight than many can extract in the market. We have a direct lending commercial real estate team with more than 40 members. That team helps to underwrite and research the commercial real estate industry. We believe that’s a massive information advantage.

Similarly, we have a bank loan team with more than 50 members, who provide insight to the issues embedded within CLOs. That’s a deep reservoir of knowledge. On the mortgage side, we have some of the broadest mortgage and prepayment analysis teams that share information across the agency and non-agency segment to further our detailed understanding of each security. Culturally, we believe in information sharing and researching securities with as much detail as possible.

We own more than 1,000 securities in any sector, so we are diversified enough to avoid overconcentration in any single name that could hurt us. We tend to run highly diversified portfolios and our research process supports that approach. In fixed income, we believe that we are not paid to overly concentrate.

Q: What is your decision-making process? Who is responsible for the ultimate decision about the fund’s holdings?

A: I am the lead portfolio manager and there are two other main portfolio managers on the strategy. Dave Goodson is our Head of Securitized and Randy Parrish is our Head of Corporate Debt. The three of us, as the senior investment team, make decisions on the risk stance and the sector, duration and yield allocations. There’s a broader leadership team, which includes some of the sector managers, but the main portfolio managers are ultimately responsible for setting the risk metrics, which result from our broad macro dialog.

Those decisions are then communicated to the individual asset teams, who have the ability to select the securities within their sleeves as they see appropriate. Dave Goodson and Randy Parrish oversee the teams doing the security selection. We emphasize the security selection rights of the teams, but the three of us, along with our broader portfolio management and risk resources, oversee the selection to ensure that it fits our overall risk stance and biases.

Our teams are mostly based in Atlanta based and have been for decades. We also have a few members in New York and London.

Q: Could you explain your research process with a couple of examples?

A: A good example would be commercial real estate, or CMBS. We have emphasized CMBS as a sector recently, but there have been concerns about how extended the interest rate cycle has been. That macro overview, combined with our detailed underwriting within commercial real estate deals, led to looking at the interest only component of commercial real estate as an interesting way to retain exposure to CMBS and to gain protection.

If interest rates did rise or the sector did slow down, we could actually benefit more in the interest only segment, because prepayments would extend in both scenarios. Higher interest rates tend to result in fewer prepayments. Any softening in the commercial real estate cycle would likely soften prepayments, all of which would increase the value of an interest only stream. That’s an example of how a potential macro view informs the teams to look for specific opportunities within a sector.

In another example, the growth of CRT, the credit risk transfer market, or the reinsurance of Fannie and Freddie obligations to guarantee mortgage payments, has been a significant growth element over the last five years. We have deep research capabilities and expertise in the area. The market has grown and has exposure to any increase in defaults within the agency mortgage universe and backstopping Freddie and Fannie’s obligation. Our non-agency teams have been strong in analyzing housing deals, non-agency mortgage risks, housing collateral value, so we have the ability to underwrite non-agency CRT deals.

CRT is an interesting market, because it has both credit and prepayment risk. If interest rates fall, prepayments accelerate. We believe that we have expertise in both components and a better ability than the market to look at the confluence of credit and prepayment risk. As the broader CRT market continues to grow, it has brought in more participants, but still offers a fertile ground for performance, taking into account the credit risk, the prepayment risk, the premium or discount element of different bonds and how that interacts with prepayment or credit risk. That’s the space of our agency and non-agency mortgage teams and it’s been an opportunity for alpha.

Q: Do you rate the securities and price targets or do you rely on external agencies?

A: We do consume external ratings by necessity, but our research teams develop a view for our securities as well. It may or may not take the form of a formal assignment of a rating. Ultimately, the credit quality for every instrument we buy is assessed by the research teams. We cannot only rely upon agency ratings to determine the risk for us; we do that on our own.

Q: How does the negative interest rate scenario impact your security selection?

A: Our view is that although negative rates provide a benefit, they also have a cost. Right now the central banks of Sweden and Switzerland are reversing course to move towards a zero rate and away from a negative rate. Negative rates may provide a benefit for a short time, but they can drive strange behavior if they are in place longer. We think that negative rates are unlikely to come to the US market. If that happens, they are more likely to be implemented in a short-term, acute manner and are less likely to persist.

We believe that we will see a growing amount of skepticism towards the effectiveness of negative interest rates over the coming years, because of the cost for the financial system. First, banks, insurance companies and other financial entities suffer with negative rates and that has an impact on growth. Second, savers suffer from a lower income stream; they would need to save more, so negative rates don’t drive consumption. The savings rate actually increases with negative interest rates and that’s a growth limitation. Third, businesses are afraid that there isn’t much central bank accommodation left and that creates uncertainty and stalls investments.

These factors offset some of the positives that come with negative interest rates. They can inflate asset prices, create long-term economic uncertainty and can increase the wealth distribution strain. Overall, negative rates can be useful in a short-term window; they are not a good long-term tool. We expect a bias away from negative rates, but we need to be prepared if they do come to the US market.

Ultimately, it is a relative game. Our job is to beat the bond market with a bond portfolio and we aim to add value on a relative basis. We prefer not to make a large overarching adjustment because that would lead to a lack of a buffer into any risk. In the U.S., where rates are still positive, a rally in a downside scenario is more likely than in Germany or Japan, where rates are already negative. That makes us focus more on price convexity where there are positive rates. Those become more attractive investments, because they have a bigger cushion in a downside scenario, even if that cushion is smaller than in the past.

That environment forces us to look at a narrower set of opportunities to protect in a downside scenario. Everything else being equal, it is harder to structurally overrisk in high yield, senior bank loans or lower rated credit, because we can’t offset that downside as much with duration. So, negative rates can perversely constrain or low rates can constrain risk taking because we believe that the downside is less protected.

The trend has biased us towards the US and assets like commercial real estate or mortgages, where rates are low, but still positive. Because a rally is still possible, that should make the US economy more resilient to any downside risk. In our opinion, 2020 looks a little brighter than 2019. We want bias towards the economies that can move away from negative rates, because they should have more upside on the margin. Overall, our analysis of negative rates informs more our view on the tail outcomes than the central tendency.

Q: How do you define and manage risk?

A: We focus on volatility and scenario analysis. A key component of risk management is how we see the different types of risk or market components correlating over time. We start with volatility and its components in terms of where it is coming from in the portfolio. When we set the portfolio allocations at the sector level, we are aware of the tracking error and we need to see that we will be paid for that tracking error. We have a strong Sharpe Ratio, above one over time. So step one is looking at normalized volatility, tracking error and Value at Risk components.

Step two is the scenario analysis, another important element of risk management. The “what if” scenarios inform us what happens if the normal volatility parameters break and that typically happens in a crisis. Step three is to examine how the different risks in the portfolio are currently correlated, how they have been correlated historically and our assumptions for the correlation going forward.

For example, when spread products are selling off and corporate and high-yield bonds are underperforming, that’s typically an environment when Treasuries are rallying. There is a negative correlation that benefits the portfolio. However, there can be dramatic shifts, like the taper tantrum and the selloff in 2013, when those correlations flip and higher rates can be met with higher spread. So we need to understand the historic relationships and run “what if” scenarios. Our three-step risk management process allows us to get more comfortable with our tail risk and to manage it better.