What do you do when you’re a fund manager free to invest in stocks and bonds to achieve a decent level of income, but both types of securities look expensive? Mark Saylor and George Cipolloni, who manage the Berwyn Income Fund, think the best move is to take a risk-off stance, be patient and wait for better opportunities to come along. “We believe strongly in being patient in the short term if we do not see much value relative to risk in any segment of our investable universe,” says Saylor.

A couple of years ago, the managers’ willingness to sit things out became apparent when they let their cash build up to 25% of assets. “At the time, the only way to get 3% to 5% yields was to go out longer on the yield curve or lower credit quality,” says Cipolloni. “We weren’t willing to do either.”

The managers have set flexible investment parameters that allow them ample room to make judgment calls in both their asset allocation and individual security decisions. They can invest a maximum of 30% of assets in small-, mid- or large-cap equities that pay dividends.

Still, on September 30, the stock allocation for the 31-year-old fund stood at a near historic low of 15%. The last time it was that meager was in 2008, before the stock market crash. The fund also has its lowest allocation ever to junk bonds, which tend to follow the stock market but also get hobbled by rising interest rates.

The managers can put up to 70% of their assets in fixed-income securities—investment-grade bonds, high-yield bonds, convertible and preferred securities, asset and mortgage-backed securities, Treasury and agency bonds, and cash.

A big chunk of the fund is in very short-term investment-grade bonds, which the managers believe offer the best risk-reward trade-off in the fixed-income universe right now.

“We can capture 100% of the yield of a 10-year Treasury bond in a 12- to 18-month corporate investment-grade bond,” says Saylor. “The bonds we invest in have yields of 3% to 3.5%, are highly rated and have strong interest coverage.” Recently added holdings in the fund fitting that profile include issuers Eastman Chemical, Lam Research and the J.M. Smucker Co.

The average duration of the bonds in the portfolio is 2.7 years, a record low, and short-term fixed income securities make up nearly half of the assets. The managers expect duration to remain at the short end of the fund’s historical range until rates on longer-term bonds rise and provide an incentive for the managers to move in. Roughly 48% of the fund’s assets mature by the end of 2019 (or in the case of convertible bonds, allow the manager to put the security back to the company by that time).

With most rate increases at the short end of the yield curve over the last couple of years, reining in duration has proved to be a good income-generating move. The fund’s 30-day SEC yield on September 30 was 3%, up about a percentage point since last year.

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