Mobile Strategy Brief: Short Duration
Mobile Strategy Brief: Short Duration
VO: Welcome to Lord Abbett’s Mobile Strategy Brief.
Joseph Graham: Hello and welcome. My name is Joseph Graham. I'm an investment strategist at Lord Abbett. Today we'll be talking about one of our most popular strategies, short duration, and we'll be doing that with the lead portfolio manager on the strategy, Andy O'Brien. Andy's a partner of the firm and has been at Lord Abbett for over 20 years—nearly his whole career.
He's a Princeton grad. He picked up a CFA along the way, so [he’s] a very tenured and credentialed guy. And more importantly, Andy, I know short duration is near and dear to your heart. It's not a hugely exciting topic for a lot of asset managers, but it is for us. We think we're a real leader in the space. And one thing we want to do today is talk about why that is. But first we want to talk about the asset class and what's so special about short maturity credit. Welcome Andy.
Andy O’Brien: Thanks Joe. There's a number of things are interesting about the short duration credit space. One thing that's particularly interesting is that in some ways it's a self-hedging portfolio. If you take a portfolio that's got a two-year duration, but that two-year duration is coming from credit-oriented assets, in some ways it hedges itself.
So if you imagine a scenario where rates are rising, well, if they're rising because people are optimistic about economic growth and they think that the Fed's going to have to raise rates to cool things down, that's an environment where credit spreads are likely to be tightening.
And so, you lose a little bit from having a two-year duration in the portfolio. But that will be offset by the [spreads on the] credit- oriented assets in your in your portfolio tightening. Likewise, in an environment where interest rates are falling, well, you’ve got a two-year duration in your portfolio benefit from that.
But you may end up giving up some of that if rates are falling because people are worried about economic growth and think the Fed's going to have to try and stimulate by easing, that's an environment where credit spreads are likely to be widening.
And so what you end up with a portfolio where your return stream looks a lot like the income of the portfolio. And sometimes you get a little bit more if the net effect of interest rate changes and spread movements is positive. Sometimes you end up with a little bit less if the net effect of those two things is a little bit negative. But mostly you earn the income on the portfolio and that's your that's your return there.
Graham: That's interesting. So [there is] almost an absolute return sort of characteristic to it because of those two that diversify. How about competition in the [short duration] space, and the size of the space? Is that something that is beneficial for short duration?
O’Brien: There's a great opportunity set. And there are two elements to that. One is just [that] the short duration space is very large. Everything that's issued ends up eventually being short duration at some point. So you've got a lot of raw material to choose from if you want.
In addition there's a lot of preferred habitat behavior at the front end. There are a lot of people who say, "You know what? I don't want to take any risk at all. I don't even want to think about it. I want to be completely safe and just buy T-bills or agencies, nothing with any unusual features or characteristics."
And so, when you have a large part of the investor base saying, "I'm not doing any work or going to make any effort whatsoever, I'm going to go the completely riskless route," that leaves people who are willing to put in a little bit of time, do a little bit of homework and think about things a little bit. It gives you a lot less competition to fight with. And so you really can find yourself with a lot of opportunities if you're just willing to do even a modest amount of work.
Graham: I see. And so Lord Abbett now is managing over $50 billion in short duration. We have for a number of years been a pretty large manager in this space. What do you think has been the secret to our success in this space?
O’Brien: Well, I think the main reason that we've been able to manage this strategy successfully is the multi-sector nature of it. You really need a team that's communicating well across asset classes. If you're focused just on one asset class and if all you do is short investment grade corporates or all you do is short asset-backed securities, you're going to have times when one part of the market is out of favor or the opportunity set in one part of the market is more limited.
When you have the full range of opportunities, when you have a team that can communicate well and say “here's what I'm seeing in this part of the market versus what you're seeing in that part of the market,” a team that can really compare and make sure that if you have a dollar to spend today, you're spending it in the most efficient place.
That's really what you need to be able to succeed over the long term in a market that's as dynamic as fixed income. So having a team that communicates well, and that's good at a lot of different things, is really a key part of that.
Graham: That's an interesting point you make about multi-sector capabilities. What are some examples of when that’s come into play where an asset class didn’t provide a lot of opportunity but you found it in other asset classes?
O’Brien: Well, an extreme example would be 2016, where we had a period of lots of debt-financed M&A and debt-financed share repurchases and kind of leveraging up of corporate balance sheets combined with the commodity price collapse. That really put a lot of pressure on corporate bonds, both investment grade and high yield markets. [They] got into a fair amount of trouble.
The epicenter was definitely commodities but just the general leveraging of corporate balance sheets had made the whole market sensitive to disruption. And that was an environment, though, where commercial mortgage-backed securities, asset-backed securities, and structured products like that really didn't feel much pain at all in that the general U.S. economy was doing well.
You didn't see spikes in consumer delinquencies or any real serious stress on the part of the [U.S.] consumer and those assets related to that [sector]. It really was a corporate credit event. And we kind of saw the opposite in 2017 as the corporate bond markets really healed and commodity prices came back.
Those things really outperformed—corporate credit really outperformed structured product going the other direction. And so, having a portfolio that can flexibly move between those asset classes and being in the right one, and then rebalancing as opportunities present themselves or as better investment opportunities present themselves in a stressed part of the market. That's one way you can outperform, by tak[ing] advantage of each asset class moving at a different pace.
Graham: And this is something, I think, we've honed over the years because we've been doing multi-sector [fixed income investing] for so long. We actually launched the first multi-sector strategy in 1971, the first one in the industry. So this process that we've developed, of finding different opportunities and building out these sector teams, has been one that's taken really decades.
So, just on that note of how things have changed over the years, what do you think about now versus 10, 20 years ago in terms of the opportunity set for short duration? Is it a better time now? Is it worse? How do you see it?
O’Brien: If you're thinking about it on a relative basis, I think it is a good time. The yield curve's inverted right now [as of September 4, 2019]. So if you're trying to find the “yieldiest” spot on the curve, three-month Libor at just over 2%, is actually “yieldier” than the 30 year [U.S.] Treasury [bond].
So if you're buying something that's at a spread [above] three-month Libor, you're buying something at the juiciest part of the curve. I think if you want to be invested now without taking a lot of risk you [might] think, “okay, we've had a fairly long period of expansion. Stock markets have done well. Credit has done well.”
This might be a good time to be conservative, not take a lot of credit risk, not take a lot of duration risk, but still earn a pretty
Graham: Yeah, that makes sense. So thanks Andy for joining us today. And we'll talk to you soon.
VO: That’s it for this edition of Mobile Strategy Brief. If you wish to learn more about the topics covered in this broadcast, or have other questions about Lord Abbett investment strategies, please contact your Lord Abbett representative. Our audio podcasts are available on iTunes, Spotify, TuneIn, Stitcher, and other major streaming media services. Thanks for listening.
Additional disclosure for this podcast:
M&A refers to mergers and acquisitions, the consolidation of companies or assets through various types of financial transactions.
LIBOR is an interest rate at which banks can borrow funds, in marketable size, from other banks in the London interbank market.
ABS refers to asset-backed securities.
CMBS refers to commercial mortgage-backed securities.
IG refers to investment grade.
Fed refers to the U.S. Federal Reserve.
A basis point is a financial unit of measurement that is 1/100th of 1%.
A credit spread is the difference in yield between two bonds of similar maturity but different credit quality.
Duration is a measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates.
Sharpe ratio is a way to examine the performance of an investment by adjusting for its risk. It is theaverage return earned in excess of the risk-free rate per unit of volatility or total risk.
Spread duration is a bond's price sensitivity to changes in a defined measure of yield spread.
The credit quality of the securities in a portfolio is assigned by a nationally recognized statistical rating organization (NRSRO), such as Standard & Poor’s, Moody’s, or Fitch, as an indication of an issuer’s creditworthiness. Ratings range from ‘AAA’ (highest) to ‘D’ (lowest). Bonds rated ‘BBB’ or above are considered investment grade. Credit ratings ‘BB’ and below are lower-rated securities (junk bonds). High-yielding, non-investment-grade bonds (junk bonds) involve higher risks than investment grade bonds. Adverse conditions may affect the issuer’s ability to pay interest and principal on these securities.
Investing involves risk, including the loss of principal. The value of investments in fixed-income securities will change as interest rates fluctuate and in response to market movements. Generally, when interest rates rise, the prices of debt securities fall, and when interest rates fall, prices generally rise. The municipal market can be affected by adverse tax, legislative, or political changes, and by the financial condition of the issuers of municipal securities. Investments in foreign or emerging market securities, which may be adversely affected by economic, political, or regulatory factors and subject to currency volatility and greater liquidity risk. The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy.
No investing strategy can overcome all market volatility or guarantee future results.
Market forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.
The views and opinions expressed by the Lord Abbett speaker are those of the speaker as of the date of the broadcast, and do not necessarily represent the views of the firm as a whole. Any such views are subject to change at any time based upon market or other conditions and Lord Abbett disclaims any responsibility to update such views. This material is not intended to be relied upon as a forecast, research or investment advice. It is not a recommendation, offer or solicitation to buy or sell any securities, or to adopt any investment strategy. Neither Lord Abbett nor the Lord Abbett speaker can be responsible for any direct or incidental loss incurred by applying any of the information offered.
This broadcast is the copyright © 2019 of Lord, Abbett & Co. LLC. All Rights Reserved. This recording may not be reproduced in whole or in part or any form without the permission of Lord Abbett. Lord Abbett mutual funds are distributed by Lord Abbett Distributor LLC.