Why this bond fund has been putting capital back to work
With experience comes expertise. Navigating financial markets successfully, over an extended period, requires teams that have seen all market conditions. Teams that have built robust analytical frameworks and have the necessary research capabilities. Having a global reach and a 70-strong team of research analysts also helps.
That’s the setup at Neuberger Berman, a firm that has been active bond managers for more than 40 years. I recently sat down Adam Grotzinger, Senior Fixed Income Manager of the Strategic Income Fund, to talk about Neuberger’s process, what the team is seeing in markets now, and the opportunities and risks on the horizon.
It is not uncommon to hear fund managers talk passionately about the processes they have built, but Grotzinger takes it to another level. He speaks proudly of the fundamental research and collaboration that lie at the centre of Neuberger Berman's culture, coupled with high-powered quantitative and qualitative processes.
"The ability to bring together all these ideas and formulate where the best relative value resides and how to construct portfolios both across sectors and within, is really what differentiates Neuberger," says Grotzinger
And that passion is a good thing when you are managing more than US$1.3 billion and have just come through one of the most volatile periods in bond market in history. It was a period, however, that the Neuberger team had been preparing for.
Grotzinger notes that whilst this year has been an extraordinary one for bonds, the team was dialling down risk towards the end of last year.
“Towards 3Q into 4Q last year, we started taking some risk off the table, reducing allocation to things like high yield, making sure our duration at the portfolio level was low, in the low end of the band that we want to manage it within, and really steadying the ship for what we thought would be pretty rocky 2022. And that's indeed what it's been”.
The other distinguishing feature of the Neuberger approach is how the team thinks about its investment horizon. Grotzinger notes that they don’t have a three or five-year view and very macro tilt.
“We like to think in 12 month windows about monetising relative value opportunities that we see, by rotating the portfolio to those opportunities. We have a lot of conviction and confidence in doing that”.
It’s an approach that has served Neuberger Berman well amid this year’s volatility.
A WINNING FORMULA
With most of the volatility now behind us, in Grotzinger’s opinion, the Neuberger team have turned their mind to opportunities.
"Having stored some dry powder from the end of last year when we derisked, we've been able to reinvest some of that as we've gone through this year at some of these cheaper valuations".
Grotzinger goes on to note that this year, while extreme, has not been particularly different to other periods of notably high volatility in the bond markets that the fund has been through in the past.
And this is where experience pays off. Grotzinger has seen this movie before and the team have an action plan to position and take advantage of the conditions.
The three things the Neuberger team are cognisant of when they see such conditions are:
- “Having our portfolio risk budget in the appropriate amount of risk coming into it, so not too much risk, not over skis, so to speak.
- "Making sure that everything we own going into it we're comfortable with. So, a well-underwritten current portfolio as we go into that environment, so that we're not forced sellers of positions as volatility starts to emerge.
- "Having a bit of dry powder going into these environments so that we can start picking off some cheaper valuation, cheaper dollar price bonds, higher-yielding bonds that are new issues because of the yield environment.”
So, how have the team been reshaping the portfolio recently?
To understand how the portfolio has changed, first some context. At the end of last year the portfolio held around 20% cash – that’s the dry powder Grotzinger was referring to. The portfolio was also running at a triple B- average rating. It had more high yield and sat around the mid-3% range.
Grotzinger goes on to explain that as this year has progressed, interest rates have moved higher and Treasury yields have become cheaper and closer to fair value, the portfolio has gradually been stepping into higher quality opportunities.
“This year we're up to a single A- average rate of portfolio. So we've moved up three notches or so on quality. And the yield has been hovering around 7%. So higher yields with a higher average quality portfolio, where we haven't felt like we need to extend ourselves to get that outcome.”
Getting a little more specific, Grotzinger highlights US bank paper, some telecommunications companies, and some short-duration opportunities within the investment grade and the double B high yield market. The latter are new issues “coming with attractive coupons off of the higher interest rate environment."
Grotzinger says that the team have also found some interesting opportunities in bonds that were issued during COVID with very low coupons and now with interest rates higher, their prices are very low. Names like Apple (NASDAQ: AAPL), like Charter Communications (NASDAQ: CHTR), where they have long bonds in the market but their dollar prices have been in the sixties or the seventies as a result of interest rates going significantly up from last year or the COVID era in which those bonds were originally issued.
“Those have interesting total return profiles that we've been picking off,” adds Grotzinger.
Wrapping it all up, Grotzinger says that the evolution has been keeping duration low at the beginning of the year, stepping into high-quality corporate names – both new and secondary market – as rates normalise, but also looking at agency mortgages where current production coupons are 4-5% depending on the month we've been in.
“We've also let our duration extend a bit at the portfolio level. So if we started the year at 2.9 years duration, we've gone out to about 4.75 at the peak and we're back down to about 4.25 and that's a function of buying some of these higher quality opportunities but not fully hedging the duration, just letting the duration run out, because we feel more comfortable that we've taken a lot of pain in interest rates already and we're closer to fair value and a lot of the downside's been absorbed”.
WHAT LIES AHEAD
While I'm reluctant to end on a negative note, the best investors have a plan for different scenarios and it would be remiss not to share with you what might change Neuberger Berman’s approach to markets.
Grotzinger says that while the portfolio is positioned for a weaker global growth environment, what would keep him up at night would be a serious deterioration not only in the global picture, but particularly in the US.
“Even if we're in this moderate growth in this soft growth patch in the US, we still feel it's something that's not overly severe in terms of the starkness of that growth slow down. And so, if you think about some of the positioning we have in some of the sectors of the corporate market, we have a very different view than perhaps the street does on where we think defaults are going to be from corporate issuers in the market.”
Grotzinger says that the team feels good about fundamentals, really good about how companies have managed their balance sheets and their maturity walls coming out of COVID, and the fact that they have pushed out maturities and have a lot of levers to pull to get through this softer growth environment.
As I said at the top, experience matters.
Learn more about the Neuberger Berman Strategic Income Fund
The Neuberger Berman Strategic Income Fund is a flexible, multi-sector fixed income strategy that seeks consistent monthly income by investing across the entire bond market with a focus on exploiting mispriced securities. If you would like first access to Adam's insights click 'FOLLOW' on Adam Grotzinger's profile.
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