For many investors, actively managed investments seem too expensive and of too little value compared with their passively managed counterparts, but this global fixed-income firm is making a strong pitch for active management in the broad U.S. fixed-income market and overseas.
When looking at the construction of the Bloomberg Barclays U.S. Aggregate Bond Index, “I don’t want to say there are inherent flaws, because there are certain rules around it,” said Doug Hulsey, head of product management at Pasadena, Calif.-headquartered Western Asset Management, an affiliate of Legg Mason with $420 billion in AUM, primarily in fixed income. However, a growing share of the securities in the Barclays Agg is from the issuers that have the most debt, he said.
For example, U.S. Treasurys have become an increasingly large part of the Barclays Agg as the U.S. government has continued to run deficits over the last 18 years and use the Treasury sector to fund those deficits, he said. “Although U.S. government debt is the ‘risk-free’ asset,” he said, “we believe there are times that [U.S. Treasurys] represent value and times that they don’t.”
Another advantage of active management, he said, is the ability to overweight and underweight investment-grade credit. For example, when the energy sector produced returns of negative 235 basis points in 2014 and negative 703 basis points in 2015, active managers who eyed some energy names (such as integrated oil companies BP, Shell and Exxon) began to see huge relative value against the investment-grade credit section of the Agg, said Hulsey, “and more broadly, pretty much again any segment of the Agg.”
As these managers began to add energy exposure in late 2015 and into 2016, he said, “This sector alone presented a tremendous opportunity to generate excess return above the benchmark.”
Active managers need “breadth and depth in the form of an IG [investment grade] credit team to really peel back the sectors of the Barclays Aggregate and determine relative value,” he said. “Certain sectors get beaten up pretty badly” and create opportunities.
Another way active managers can try to generate excess returns is by tweaking duration, said Hulsey. He noted that the 30-year Treasury started 2012 at around 3 percent, climbed closer to 4 percent at the start of 2014 and then dropped 150 to 170 basis points amid the downturn in equities, falling crude oil prices and concerns over European growth.
At that time, Western Asset Management bought more duration in the 30-year bucket, he said, because it was one of the managers that correctly anticipated economic growth and inflation (and therefore rate hikes) would remain somewhat muted.
“There is a lot of opportunity if a manager can actually go overweight the back end of the curve and ride the downward trend in the 30-year Treasury rate,” he said. For managers not expressing long duration in their portfolios when 30-year Treasury rates fall in a risk-off (i.e., spread-widening) environment, this “presents kind of a one-two punch,” he said.
Hulsey also pointed out that it’s difficult for index managers to attempt to replicate the Barclays Agg because it has 9,000-plus individual securities. Active management, on the other hand, enables active managers to express favorite sectors, issuers or issues, he said.