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

PineBridge began sub-advising the SunAmerica Strategic Bond Fund in 2002. We were originally part of AIG Investments and were sold to Pacific Century Group in 2010. We are now a privately held firm. 

The strategy began in 1993 and the fund is the only retail mutual fund for the strategy. Our assets under management in this fund are about $400 million, with over $1 billion in the overall strategy. 

The underlying concept of the fund is that by investing in the key sectors of the broad fixed-income universe, which experiences relatively low correlations over time, and making tactical shifts to those allocations, superior risk-adjusted returns can be generated over the long term. 

It is a multi-sector strategy, and unlike our peers, we do not use derivatives and non-cash elements. We also do not make big allocation swings. We’re transparent about what we buy and sell, so you always know what you get. 

We make top-down strategic allocations to various asset classes, while being credit selective at the sleeve level. We make allocations across leveraged finance, investment grade credit, securitized, emerging markets and non-US dollar currency. These security selection decisions drive about 60% of our returns at the sleeve level. We stress credit research and picking the right securities. 

Q: How would you define your investment philosophy?

I’ve been a fixed income manager for nearly 30 years. I have learned that as a fixed income manager you essentially are focused on getting par at maturity, and therefore you shouldn’t bet what you can’t afford to lose. It’s about picking the right credits and making the right sector allocations in a disciplined way, that limits risk to the portfolio. 

We are a security selector but we do not establish overly large position sizes. Nevertheless, in names we do like, we take positions that will impact returns. Overall, we think that a more balanced approach pays off over time. The idea is to pick the best securities we can find, and take greater idiosyncratic risk versus broad market risk, but not bet the portfolio on a limited number of positions. 

Unlike some of our larger competitors, we are not in the company of those managers who are essentially forced to mimic an index. We can position the portfolio in a way that reflects our beliefs, generating solid risk-adjusted returns through strong information ratios and measured bets. Ours is an integrated portfolio management process—everyone is involved: portfolio managers, analysts, and traders. 

Our framework focuses on fundamentals, valuations, and technicals of the market. Analysts are typically more fundamentally driven, while the traders and portfolio managers are more apt to contribute from a valuational and/or technical perspective. 

Another strength of our sleeve-level performance is upside/downside capture. Rather than refuse to admit when we are wrong and hold positions that are not optimal, we take steps to mitigate those mistakes, which leads to better upside/downside capture. 

In fixed income, you win by getting par or your money back. We don’t bet everything on duration or credit, but focus on security selection. We limit how much risk we take in terms of credit and are cautious about the use of duration as a source of return. 

We are a smaller, mid-sized manager and use an equity-type measure, called active share, which measures a portfolio’s ability to differentiate itself from an index. We focus on maintaining a higher active share. 

Q: Why is that important to you as a fixed income manager?

I first started witnessing concern about manager size during the financial crisis. Larger money managers that were forced to own larger positions per name were very limited in their ability to reduce exposures. In effect, if you were a large manager that was long a billion dollars of Lehman debt, you’d have to love it because there was no way you could sell it, no way to get out of it. 

But smaller/midsize managers who want exposure to a certain financial name can gain exposure to that name in a very specific manner. For example, if I like a particular bank’s subordinated debt with a 20 year maturity, I can simply buy that security and that can be my entire exposure to the name. Larger managers have to buy multiple bonds to achieve that same level of exposure—bonds with different maturities, at different levels of the cap structure—and they end up establishing positions which are much more like the respective index. We, on the other hand, as a smaller manager, have relatively low tracking error which focuses on idiosyncratic risk. We focus on driving performance at the security level, which generates stronger risk-adjusted returns with a higher active share.

A lot of our competitors might have strong returns, but not necessarily strong risk-adjusted returns, because they take huge bets in credit, duration, or something else against their benchmark and manage to be right on those positions. We are much more controlled in terms of risk and more focused on what we are good at: security selection. That is our focus— whether its investment grade, emerging markets, or high yield. Our blend of different asset classes, over time, has relatively low correlation, hence the better risk-adjusted return generation at the fund level. 

As ours is a credit strategy, it performs well in rising rate environments, when the economy is doing better, as credit spreads typically tighten to reflect this dynamic. Over the short term, the strategy may underperform on any move higher in rates as investors seek to shed duration of all types, nevertheless, over time that corrects because higher rates reflect a stronger economy. Overall, the strategy has had only three negative years in its 23 year history.

Q: What is your investment strategy and process?

We have an investment strategy meeting at least once a month to review risk across all asset classes: equities, fixed income, and alternatives, as well as a fixed-income asset-allocation team meeting that I chair, a meeting that is key for this strategy. We review everything using a framework of fundamentals, valuation, and technicals. 

Since the financial crisis, we also take a top-down, scenario-based view. After the crisis, we saw a tremendous run-up in public sector debt, which told us that rates would stay low for a very long time and economies would be more sensitive to small changes in interest rates. In addition, we thought that tail-risk had increased. Therefore, we thought that it made sense to try to assess how large those tails might be. Therefore, each asset class manager outlines the probabilities of the various scenarios: recession/deflation, high growth/high inflation, with the central case being what has become the new norm: more of a muddle-through economy unfettered by inflation, yet burdened by massive debt. 

As a result of that review, we make any necessary tactical and strategic shifts—because our core belief is that, over time, sticking to these asset classes generates stronger risk-adjusted returns. 

We also have a rates and currency review that generates a global rates view and ranks currencies. In this strategy duration is not a major driver of our returns. Nevertheless, we do take a tilt toward duration in the range of +/- 1 year. We have been basically neutral to long duration for the past seven years because we think rates will continue to stay low. 

In addition, we have a sector scorecard meeting, a sleeve-level review of sector positioning: what worked and what didn’t, and how we should act going forward. We rank relative value, ranking names within the investable universe per sector on a scale of 1 to 5, strong buys to strong sells, relatively. These rankings are then input into our Credit Analysis Platform, which is a web-based tool that is available to all members of our investing team. Any time a recommendation changes for any name, the system sends out an internal email alerting everyone of the change. 

Q: How long will this low-rate regime continue?

Over the last several months, we have seen the bear case likelihood rise, telling us to consider pulling back on some risk. Accordingly, we reduced our allocation to high yield and emerging markets. We don’t feel we are in for any classic cyclical correction at the moment. Ours is a buy-on-weakness approach in an environment of continued easy monetary policy. We think this unprecedented monetary policy stance is required in an environment of relatively poor fiscal and regulatory policy. This type of environment makes it very difficult for the Fed to raise interest rates. Spending programs may temporarily add growth optimism but we will inevitably return to sluggish growth and even more debt. 

That said, it is not a bad environment for fixed income, because the central banks will want to keep rates low to support debt levels and government spending. Lower rates driven by central bank accommodation are not enough to generate sustainable growth. Fiscal and regulatory adjustments are needed. Low interest rates usually accompany high public sector debt levels. For example, in the U.S. the period during World War II was the last time the U.S. had such a high debt-to-GDP rate. Then, the 10-year U.S. Treasury did not rise above 2.5% throughout the entire 1940s. 

When the war ended, however, the economy boomed, strong economic growth ensued and the economy grew into the debt levels. Currently, I do not see any situation where an economic boom may happen. The bear case states that as long as rates are below nominal GDP, debt can continue to grow. 

Looking ahead the risk I see is that the Fed will feel overly confident in raising rates, perhaps too far given the efforts around fiscal policy that we are likely to see. This will create an environment where central bank policy error is a real possibility. Nevertheless, while this event may cause volatility, we think that ultimately the Fed should be supportive, so we are taking a buy-on-weakness approach in terms of this nontraditional credit cycle. And even with a Trump administration, while rates are likely to be pressured to higher levels, I do not think rates will rise significantly. I think we are locked in a low interest rate environment for the foreseeable future. 

Q: Has your view of the fixed income sector changed?

I feel that liquidity in the fixed income sector is now more constrained, due to regulation. Ten years ago, the dealer community would carry significantly higher inventory levels. Inventory levels now are just a fraction of those levels given how expensive credit inventory has become due to regulatory adjustments. 

As an example, in the period before the global financial crisis, when the markets were weaker, a dealer was willing to buy bonds and build an inventory because they were fairly confident they would be able to sell them as the market recovered. Today, because of regulatory restrictions, dealers cannot act as the conduit of liquidity that they did in the past. In effect, everyone is an investor now. 

Therefore, I believe we are at risk to have more severe drawdowns due to this dynamic. These conditions necessitate taking a longer-term view in the market. The average trading volume—trade size—has gone down because of lower liquidity. However, as we are nimble we are better positioned in this type of environment. Also, the number of credit exposures has not really increased, but the number of securities has increased, further enhancing liquidity. I do not see this changing unless dramatic changes are enacted with regard to current regulatory rules. 

Q: Can you provide an example of how you look for opportunities?

Market conditions that provide opportunities to generate alpha include M&A— mergers and acquisitions activity. These types of transactions often feature businesses with good cash flow that lever up to buy other businesses, commit to debt reduction, and typically issue new debt at a concession.

For example, earlier this year, a well-known large Food and Beverage issuer purchased a competitor and issued $46 billion in debt to fund the purchase. We anticipated this opportunity because, despite the increase in leverage, the issuer was seen as a strong business with tremendous cash flow that was committing to paying down debt. 

In participating in this new issue, while larger managers may have received more bonds, our share comprised greater exposure—170 basis points in our investment grade credit portfolios. In addition, we focused on exposure along the curve, and put the largest position in the 20-year maturity, as we felt it was the most attractively priced of all maturities on the curve. 

We thought the fundamental credit profile and valuations were very attractive looking ahead. Our analysts have had discussions with management and we have great confidence that they will do what they say in terms of paying down debt and maintaining their credit rating. 

What would make us sell this particular bond would likely be valuation. Right now it’s still cheap, but if valuations got to a level more commensurate with comparable issuers, and there was a risk of perhaps more M&A, we would look to reduce our position. 

Right now, we are watching the potential combination of two very large companies in the Telecommunications sector, although it probably has a low probability of getting done at this point. But when the news first emerged about the potential acquisition, the bonds issued by the company being acquired widened 30 basis points and so we bought it. In our view, at that time, we speculated a large new issuance might bring in other buyers, higher quality buyers like we have seen frequently in the last few quarters. We also felt that if the deal did go through, the bonds issued by the acquired company would still likely trade at a premium to those issued by the acquiror. 

Q: What is your portfolio construction process, and what, if any, benchmarks guide you?

This is a multi-sector strategy with the flexibility to allocate across US Investment Grade, Emerging Markets, High Yield and non-US dollar assets. We set broad asset class limits for each segment. Also, at the security level, our limitation is typically 3%, but a 2% position in any name is a very large position in our strategy, unless it is bigger in the index. 

Each sleeve has a specific benchmark, and we have a custom benchmark that we think better measures the positioning in the portfolio. For the investment grade credit space, which is both credit and securitized products, we use the Barclays Capital Aggregate Bond Index (formerly the Lehman Aggregate.)

For the emerging markets space it is the EMBI Global Diversified Index, and for high yield, we use the Barclays U.S. Corporate High Yield Index. There is also the CitiGroup World Government Bond Index, which is our non-dollar component. 

We use a custom benchmark, which is 35% investment grade aggregate, 35% high yield, 20% emerging markets, and 10% non-dollar, because we think it better measures our risk versus the long-term strategy of the fund. 

The reason why high yield and investment grade form the largest positions is because these are the largest, most liquid asset classes and have, relatively speaking, the lowest correlation, which is important when your focus is long-term risk-adjusted returns. 

Q: How do you define and manage risk?

While I might say the greatest risk is not taking one, we have a risk manager to ensure the risks we take are the ones we articulate, the ones we say we want to take. She is more of a strategic risk manager than a compliance-oriented one. 

In other words, if we like high yield CCCs, we want to see that risk increase in the portfolio at such a level that it will have a meaningful impact on our performance. Also, we likely don’t want to see that additional credit risk be offset by some other movement in the portfolio. 

During the financial crisis, we experienced a period when a lot of financials were downgraded to high yield. Most high-yield managers underperformed the index, given their relatively light positioning in the financial names as the bonds subsequently rallied significantly following the “stress tests” that were performed on financial institutions to ensure their viability. 

In that kind of dynamic, where all of a sudden high-yield financials represent a much larger portion of the high-yield market, we have to monitor our holdings not only at the sleeve level but at the portfolio level.

That is something risk management would examine—our view in financials and whether we are positioned as we should be. The risks we take must be in line with our views while not being excessive. For instance, ensuring that I do not sell a financial while our high yield portfolio manager buys one, unless it is a structured swap of some kind that we have discussed, designed to maintain allocation to that asset class to pick up yield, or vice versa. It’s ensuring the risks we take are aligned properly and make sense. 

We embrace risk, but want to keep it at a level where, if we are wrong, we will still live to fight another day.