In fact, according to a global survey of 200 professional fund buyers conducted by CoreData Reseach2 for Natixis Investment Managers’ Center for Investor Insight, active management may be more relevant in 2018 for portfolios.
Fund buyers see volatility, favor active to manage it
The fund buyers surveyed anticipate volatile markets in 2018 – and 80% of the respondents say rising rates and volatility favor active management. In fact, 84% say active management offers better downside protection than passive management. In addition, two-thirds see active management as the better choice for taking advantage of short-term movements. Even though 95% of professional fund buyers say passive strategies are better suited to minimizing management fees, the majority find that active provides greater value in meeting critical portfolio objectives.
Top three market risks for fund buyers
Professional fund buyers rank their top three risks as rising interest rates (55%), asset price volatility spikes (47%), and liquidity (36%). But they are split on what it will mean for portfolio performance. Most see rate increases as a negative for overall performance (49%), but three in ten see a change in rates as a potential performance boost. Of course, the split in opinion may be driven by their differing investment horizons.
Dan Fuss, Vice Chairman of Loomis, Sayles & Company and Portfolio Manager on its Multisector Team, has actively managed bond portfolios through countless interest rate cycles, market turbulence, and a global financial crisis in his 60-year career. He is also expecting increased volatility and interest rates in global bond markets. As a long-term investor, however, Fuss sees several upsides to this scenario. “Rising interest rates mean higher yields and that is good for reinvestment risk. It allows us to be patient. Take a little money off the table and then deploy it at a higher rate,” said Fuss.
The Fed has already raised interest rates six times in this cycle (as of April 30) and will likely continue its slow upward move for a while. “We are heading to the 2% inflation mark here in the US, and possibly going higher. So another two or three rate hikes by the Fed seems about right for 2018,” said Fuss. But the big issue, he thinks, is not what the Fed is up to. “The big influence is geopolitics and how that affects the economy, inflation and what the Fed does,” said Fuss.
Playing defense in the bond market
In recent months, Loomis Sayles’ Multisector Team has been reducing risk and building up reserves, including significantly cutting average maturity. “We favor a higher level of reserves in the form of cash, short-maturity US Treasuries and investment grade corporate debt,” said Fuss. In the current environment of elevated macro risks and increased volatility, he believes focusing on areas where the market may be mispricing risk makes sense. When the team sees significant dislocation, they will be ready to use their reserve allocation in these areas.
Having the freedom to roam across global fixed income markets, as well as make allocations to out-of-benchmark securities, can provide value and diversification, as well. Such areas where Loomis’ research is finding selective opportunities today are convertible bonds in biotech and cable/satellite and high yield corporate bonds in the energy sector.
Actively pursue value when volatility strikes stocks
Investor worries over trade tensions between the US and China, inflation, and potential regulations for big tech led to declines across global stock markets for Q1 2018. In fact, the S&P 500®3 recorded its first quarterly loss since 2015. This type of volatility can create an ideal buying time, says Bill Nygren, Chief Investment Officer, US Equities, and Portfolio Manager at value-focused Harris Associates.
“We welcome a moderate degree of volatility because it often affords opportunities to invest in solid companies at discounted prices. The recent multi-month period of stock price appreciation made it more challenging for value hunters like us to find bargains,” said Nygren. As long-term value investors, Nygren and his colleagues look to identify growing businesses managed to benefit their shareholders. “We will purchase stock in those businesses only when priced substantially below our estimate of intrinsic value. After purchase, we patiently wait for the gap between stock price and intrinsic value to close."
A high-conviction, concentrated portfolio manager, Nygren and his team rely on their consistent value discipline and stock-selection process to drive performance for shareholders – not the benchmark. Not surprising, high active share1 is a byproduct of the firm’s investment process.
Active share in fixed income?
Active share has received a fair amount of attention since the work of Martijn Cremers and Antti Petajisto was published in 2009. But active share is more widely used to measure equity portfolios’ holdings compared to their benchmarks. Fixed income portfolios tend to be left out of active share discussions because bonds have certain key characteristics such as issuer, maturity, credit rating, coupon, etc. that make security-specific analysis more difficult. However, you can still sort out how a fixed income portfolio differs from its benchmark. It may not be a precise measure of active share like you get on the equity side, but it will tell you something about how active a bond manager may be.
For example, some fixed income managers can use “plus” sectors (such as bank loans, currencies, emerging market debt, high yield credit, TIPS) that reside outside the benchmark, or alter their weights to sectors that are included in the benchmark. By definition, this would result in active risk, if not “active share.” If you compare Loomis Sayles’ core plus bond strategy to its benchmark, the Barclays Aggregate Bond Index – a high quality index comprising roughly 70% US government securities and about 30% dedicated to other sectors – it would look almost flipped today.
“About 29% of our strategy is currently allocated to US government securities that reside within the Index, with the other 71% allocated to non-Index sectors, including higher yielding sectors such as investment grade and high yield credit, credit securitized, emerging market debt and non-US dollar,” said Peter Palfrey, co-manager on the Loomis Sayles Core Plus team.
Notably, the allocation outside of the US government portion of the Index also includes short agency discount notes, treasury bills, and long-dated TIPS -- all of which Palfrey believes help to improve the overall quality and liquidity of the portfolio during the late expansion phase of the credit cycle. This positioning also reflects the team’s efforts to minimize portfolio interest rate sensitivity as the Fed gradually pushes interest rates higher.
Tactical flexibility to navigate rising rates
Palfrey believes today’s ever-evolving credit cycles and complex global market demand tactical flexibility. While his team’s approach is benchmark-aware, it certainly doesn’t mirror a benchmark. “We seek to populate our portfolios with what we believe are the best ideas for each unique market environment and deliver principal protection and solid risk-adjusted returns,” said Palfrey.
While there is always a place for passive investments in portfolio construction, highly skilled active managers should not be overlooked in today’s complex markets.
2 Natixis Investment Managers, Global Survey of Professional Fund Buyers conducted by CoreData Research in September to October 2017. Survey included 200 professional fund buyers in 23 countries.
3 S&P 500® Index is a widely recognized measure of US stock market performance. It is an unmanaged index of 500 common stocks chosen for market size, liquidity, and industry group representation, among other factors. It also measures the performance of the large cap segment of the US equities market.
The views and opinions expressed represent the subjective views of the contributors as of April 30, 2018. They are subject to change at any time based on market and other conditions. There can be no assurance that developments will transpire as forecasted. This material is provided for informational purposes only and should not be construed as investment advice.
All investing involves risk, including the risk of loss. There is no assurance that any investment will meet its performance objective or that losses will be avoided. The ability of an actively managed investment to achieve its objective will depend on the effectiveness of the portfolio manager. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
High active share is not a guarantee of outperformance or positive performance.
Diversification does not guarantee a profit or protect against a loss.
No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
Natixis Distribution, L.P. is a limited purpose broker-dealer and the distributor of various registered investment companies for which advisory services are provided by affiliates of Natixis Investment Managers.
Fixed income securities may carry one or more of the following risks: credit, interest rate (as interest rates rise bond prices usually fall), inflation and liquidity. Interest rate risk is a major risk to all bondholders. As rates rise, existing bonds that offer a lower rate of return decline in value because newly issued bonds that pay higher rates are more attractive to investors. Equity securities are volatile and can decline significantly in response to broad market and economic conditions. Value investing carries the risk that a security can continue to be undervalued by the market for long periods of time. Inflation protected securities move with the rate of inflation and carry the risk that in deflationary conditions (when inflation is negative) the value of the bond may decrease.
Natixis Distribution, L.P. (fund distributor, member FINRA | SIPC) and Loomis, Sayles & Company, L.P. are affiliated.
Natixis Distribution, L.P. is a marketing agent for the Oakmark Funds, a limited purpose broker-dealer and the distributor of various registered investment companies for which advisory services are provided by affiliates of Natixis Investment Managers.
Natixis Investment Managers includes all of the investment management and distribution entities affiliated with Natixis Distribution, L.P. and Natixis Investment Managers S.A.