She considers her management style to be a hybrid blend designed to track and beat its benchmark consistently over time. On the passive side, the fund maintains the same duration as its benchmark to avoid making interest rate forecasts, a feat that Stanek believes is nearly impossible to achieve successfully. On the active side, the fund’s strategy tinkers with the benchmark yield curve by selecting bonds with maturities and yields that work best.
The active side of the strategy comes into play with its sector allocation and individual security selection, with managers scouting out the best relative values among issuers and individual bonds.
The approach has helped both funds beat their benchmarks consistently over the long term. The Core Plus Bond Fund, which can invest up to 20% of its assets in below-investment-grade securities, has performed better than the Bloomberg Barclays U.S. Universal Bond Index over the last three-, five-, and 10-year periods, and since its inception it has ranked in the top 15% for returns in its Lipper peer group. A low expense ratio of 0.30% for institutional shares also provides a tailwind against the competition.
Active management tweaks worked well for the fund in 2019 as institutional shares posted a return of 10.11% while the benchmark posted only 9.29%. The fund has historically favored investment-grade U.S. bonds and the financial sector, which outpaced other parts of the bond market last year and accounted for much of the fund’s outperformance. It also helped that the fund had less than the benchmark did in government bonds, which did not perform as well.
While the rally in investment-grade corporate bonds was good news for the Baird Core Plus fund, it also brought their yields closer to those of comparable duration Treasurys. At the end of 2018, U.S. corporate bonds held a yield advantage of 153 basis points, a spread that ran slightly above its 145 basis point average since 2009. By the end of 2019, the corporate yield advantage had narrowed to 93 basis points, a shift that made it less attractive for investors to take on credit risk.
There is also growing concern among some investors about the increase in the number of issuers that populate the “BBB” market, the lowest tier of investment-grade ratings. Nearly half the bonds outstanding globally have that rating, whereas they represented only 10% of the universe in 1974. The plethora of these bonds raises the odds that billions of dollars in securities could get knocked below investment grade in a recession.
Stanek says the current uncertainty heightens the need for active management, and one way of doing that lately has been to let her Core Plus fund’s overweight position in corporate bonds migrate a bit lower.
“With spreads tighter than last year, we’ve become more selective about picking our spots in the credit market,” she says. “But there are pockets of opportunity. Corporate credit fundamentals remain solid, and it’s still a pretty constructive environment.”
She points out the Core Plus fund has a number of tools at its disposal to control risk. At year’s end, there were nearly 1,400 bonds in the portfolio, which lowers individual security risk. Lower-rated bonds usually have smaller individual position sizes in the portfolio (and shorter durations) than those with higher ratings.
“We look at the portfolio as a whole and try to figure out how the various parts work together,” she says. “The key is finding where we are being paid to take risk, and where we’re not.”