How Fixed Income Asset Management Rises Above Interest Rates

Taking part in a Fixed Income Master Class on AssetTV in February, Brian Kennedy, Co-Portfolio Manager, Loomis, Sayles & Company Full Discretion Team, explains how his team managed portfolios through the Federal Reserve’s interest rate hike action to tame inflation in 2022. He then delves into duration decisions, the bond yield advantage in 2023, and the types of securities that are most attractive in the later phases of the business cycle.

Here are some highlights:

How have you been managing duration?
We spent the last year considering the flexibility that our strategies allow us in fixed income asset management, the low interest rate environment, and the extension of duration on some of the indices. Because we are more of a benchmark-agnostic type of manager, we were really able to take advantage of that and spent the better part of 2022 significantly short our benchmarks, in some cases three-plus years short. However, we've been adding duration over the last several months to help us get back to flat duration versus our benchmarks.

Given the current environment, how do you go after alpha?
Typically, security and sector selection drive most of our alpha generation. In 2023, we expect that the yield advantage associated with security and sector selection will again be the primary drivers of alpha. The alpha really does come from the security selection that comes from what we call our six pillars of bottom-up security selection – four of which we find really relevant currently.

Can you talk about a few of the “pillars” your team is finding interesting ideas in today?
The first pillar is something we call “Upgrade Candidates.” We've recently seen a tremendous amount of companies cross over from high yield into investment grade. We still think there are some candidates out there that can do that, whether it's over the next six months or the next couple of years. So that's an area we continue to focus on with our high yield allocations. As we come to the end of this credit cycle, we want to be careful about “Avoiding the Losers,” which is another pillar we believe in. Why? Because sometimes you can win by not losing in these portfolios. So we want to be careful about security selection as we get closer to an economic slowdown. “Cheap for Rating” is another pillar that we're always identifying in seeking bonds we think could possibly be on a fundamentally upward trajectory as far as their ratings are concerned.

What if we move into recession?
We are watching “Stressed and Distressed” sectors of the market. We're not seeing a lot of that right now, but we're certainly keeping our eye out for it. And if global economies do slow, we're likely to see a bigger cohort that we can pick from there. Then finally, the “Fallen Angels” pillar would come into play. Certainly, if we do see an economic slowdown, we will start to see some downgrades. Typically, fallen angels can be some of your best performers over the long term.