For such a sedate asset class, bonds seem to spark a huge amount of rivalry. That only intensifies when you reach the West Coast.
While feuds between Pimco and Janus and between DoubleLine and TCW dominated headlines in years gone by, one Los Angeles shop that has managed to stay out of the spotlight – or rather, to avoid getting caught in the crossfire – is Pasadena-based Western Asset Management Company.
Despite having a lower profile than some of its noisier neighbors, the Legg Mason-owned manager is no small shop with $420 billion in assets, and has risen to the top of the competitive Core Bond category based on three-year total returns to the end of August.
However, on a risk-adjusted basis, the Western Asset team – consisting of Citywire AAA-rated Mark Lindbloom, AA-rated Carl L. Eichstaedt and + rated S. Kenneth Leech – has to settle for second place, pipped to the post by TIAA-CREF Bond’s managers, the AAA-rated Joseph Higgins and A-rated John Cerra.
The Western Asset fund’s largest sector allocation at the end of June was mortgage-backed securities (MBS), which made up 36.3% of the portfolio. Over August and September, the team upped this allocation to 49.4%.
The trio made the move despite, or rather because of, the Federal Reserve’s initial hint and later confirmation that it will begin to unwind its historic quantitative easing program from October.
The central bank will begin to reduce its $4.5 trillion in bond holdings by holding back $6 billion of maturing treasury proceeds per month – a cap which will rise incrementally by $6 billion every three months until it is holding back $30 billion a month in a year's time. For proceeds from its holdings of agency debt and MBS, the cap will be $4 billion per month initially, increasing by $4 billion every three months over the course of a year, until it is holding back a total of $20 billion per month.
While some MBS investors are concerned by the reduced role of the Fed in the market, the Western Asset team is broadly buoyed by the central bank’s plan.
‘We added agency MBS to both the Core and Core Plus,’ Lindbloom said. 'The reasons are continued low volatility and our view that the Fed buying fewer MBS will not be disruptive.’
The hunt for yield means that buyers will not be in short supply, he argued. ‘In fact we have seen much better buying from other domestic investors looking for yield, quality and liquidity,’ he said.
Other changes in allocations have seen the team rotate out of corporate credit and into emerging markets. The latter is up as a proportion of the fund, from 4.1% in June to 5.5% in September.
In South America, Lindbloom likes Brazil for both dollar and local currency debt, as well as Mexico and Argentina. In Asia, he highlighted Indian and Indonesian bonds. ‘We think long-term India and Indonesia offer very good return prospects in the dollar and the local markets. However, in India, it’s almost exclusively local,’ he said.
By contrast, Higgins and Cerra's TIAA fund had a much lower allocation to MBS at the end of June – just 15.6% – but held more asset-backed securities than the Western Asset strategy – 16.8% versus 4.9% – according to the two groups’ factsheets. Higgins and Cerra’s top sector allocation was to corporates, which has driven returns this year. In their second quarter commentary, the pair said: ‘While market volatility has been low, we remain vigilant in monitoring the potential for rising interest rates or the impact of policies to reduce the Fed’s balance sheet.
‘The TIAA-CREF Bond fund is positioned fairly conservatively, with the capacity to take advantage of opportunities if volatility increases. Relative to the benchmark, our investment-grade holdings are generally of high quality, and our asset-backed securities emphasize liquidity and shorter duration.’