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Director, Fixed Income Strategies, Manager Research
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Morningstar, Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. The company offers an extensive line of products and services for individual investors, financial advisors, asset managers, retirement pla... more.
Director of Investor Programs
Prudential Financial Inc
With the Fed considering raising the interest rate again this year, Morningstar's Sarah Bush explains how it could affect different bond categories.
The mortgage allocation of the Pimco fund may also have increased as managers maintained its nonagency bonds while selling securities in other sectors, said Sarah Bush, a senior analyst at research firm Morningstar Inc.
By Christine Benz and Sarah Bush | 04-07-2016 12:00 AM
Morningstar director of fixed income Sarah Bush explains how different bond categories performed in a quarter that exceed many investors' muted expectations. Joining me to provide a recap of the first quarter for bond funds is Sarah Bush. She's director of fixed-income strategies in Morningstar's manager research group. Sarah, thank you so much for being here. Sarah Bush: Thanks for having me, Christine. Benz: Sarah, a lot of hand-wringing going on about bonds and bond funds over the past several years, really five years now. Bush: That's absolutely right. Bush: They did, and as you point out, that's actually been a difficult market for a while. Bush: Right, we saw a pretty strong rebound in high yield mostly in March. Bush: And again, non-dollar was a part of the market that really had a rough 2015. Bush: So, again, actually the muni market is interesting because last year high-yield munis did pretty well, so a little bit of a flip from what you saw on the taxable markets. That's continued into this year, so high-yield muni categories are doing better basically across the board. Bush: Meaning they'd be, right, from a valuation perspective they'd be less attractive. So, and then if you kind of look more broadly at the muni market, a lot of times it could be driven by technicals and what inflows and outflows look like, and flows have been fairly strong. And credit, there are a few names out there of people are certainly worried about--Puerto Rico, here in Chicago, Illinois. Benz: Right. Bush: We all talk about that a lot. Bush: Right. Bush: Right, so both of those are kind middle-of-the-pack here today to lagging a little bit. Those are both shops that have had kind of bearish, conservative view on durations, so the fact that we've seen such a rally in a long Treasury isn't something that's going to help them. Nothing dramatic though--they're still pretty much middle of the pack. Benz: OK, PIMCO Total Return? Bush: PIMCO Total Return's having a little bit of a rougher year. Bush: That's definitely been the case and that's actually been the case for several years now. Bush: It's early days and we don't rate it yet, but I would expect... They're definitely thinking about this as a core fund, so I think it's going to be fairly benchmark-conscious. Bush: It is, yes. Sarah, thank you so much for being here to share your insights. Bush: Thanks very much, Christine.
By Sarah Bush, Morningstar's director of fixed-income manager research strategies.
Sarah Bush: And I would say that's pretty much a consensus view from all the managers that we talk to, and that's not common necessarily to … get that kind of consensus around Fed policy, but we're definitely hearing that across all of our portfolios we cover. Bush: The Fed has also signaled through its dot plot that it expects a lower terminal rate several years out. Castagna: I would agree with Sarah. Bush: Increases in bond yields are ultimately good for you if you are long-term investor, because that's where most of the total return in bonds comes from. And as Sarah said, when rates start rising, you collect more yield on your portfolio, and that's actually a very good thing. Sarah, have you talked to managers who are concerned about this? How are they managing what could potentially be defaults in energy? Bush: I think that's definitely something, when you are looking at high-yield specifically, to understand. I would agree with Sarah: On the energy-related side you need to sort through the investment-grade energy exposure versus the below-investment-grade energy-related exposure. Glaser: Sarah, do you have any concerns about liquidity? Bush: We spend a lot of time talking to high-yield managers, but also managers across the other sectors that we cover, about liquidity. Bush: That's actually something that we saw with emerging markets. Bush: That's really been a very volatile asset class and, looking at flows, a difficult experience for investors to handle. Bush: Break-evens are quite low even if you think that inflation isn't going to shoot up dramatically at this point. Bush: I would say that we are seeing a lot of managers favoring corporate credit. Bush: We've seen pretty strong flows into muni bonds. Bush: I would second what Mary Ellen said. Bush: Diversification is very, very, very important. Bush: I think high yield can present some interesting opportunities from time to time. Bush: I think that makes sense. Bush: A couple of points. Versus, as Sarah indicated, the diversification benefit and then the ongoing active management. What are some of the downsides, and also upsides, of going into an index strategy, Sarah? Bush: We have seen a lot of interest. It has been interesting that the Barclays Aggregate Index has done relatively well in the intermediate-term bond category in 2014-2015. It's looking pretty good year-to-date. Bush: I think benchmarks are still very useful. Glaser: Sarah, I wanted to ask you about some of the big flows that we've seen into a lot of bond funds, particularly after some of the turmoil we saw at PIMCO earlier. Mary Ellen, I want to ask you how you are handling the inflows afterward, but Sarah, could you give us a universal take first? Bush: We've had obviously a lot of conversations. Bush: Also I just wanted to note that those flows have been fairly diverse, too. Bush: I would agree the Financial Times is very good. Bush: Vanguard has a product that's focused on the shorter TIPS. Bush: That's actually one of the big challenges with those funds. And as Sarah mentioned, at least in the early going, in the last several years, many of the absolute return and unconstrained funds have failed to meet their objectives. Bush: A lot of them are quite expensive. Bush: First of all, they are not cash; they have a little bit of risk… but this is also a part of the market that has a checkered history. Bush: We look at on a relative basis. Bush: 30 basis points on the institutional share classes of those funds. Mary Ellen, Sarah, and Dario, I appreciate you taking the time today to share your thoughts on bonds. Bush: Thank you.
"Long-term Treasuries are very, very sensitive to interest rates, and when they move, they tend to move very dramatically," said Sarah Bush, director of fixed-income strategies, manager research, at Morningstar in Chicago.
The Federal Open Market Committee raised the federal funds rate by 25 basis points in December after years of keeping it at zero to 0.25%. Although the rate hike had a negative impact on long-term bonds, Ms. Bush said market focus might have been a more significant factor than duration on the rise of intermediate-term strategies. "Unusual parts of the market pop up, and I think it's probably more about those sectors having performed rather than intermediates," she said.