A challenging landscape tested most bond funds in 2013, but a few managers stood out as worthy contenders for this year's top prize.
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By Michelle Canavan Ward, CFA | 01-08-14 | 06:00 AM | Email Article
Who should be Fixed-Income Fund Manager of the Year?
Dodge and Cox Investment Policy Committee--Dodge and Cox Income
Tad Rivelle, Stephen Kane, Laird Landmann--Metropolitan West Total Return
Dan Fuss, Matthew Eagan, Elaine Stokes--Loomis Sayles Bond
Dan Ivascyn, Alfred Murata--PIMCO Income
Mark Vaselkiv--T. Rowe Price High-Yield

Earlier this week, we announced the nominees for Morningstar's Domestic-Stock Fund Manager of the Year and International-Stock Fund Manager of the Year. Next up are the Fixed-Income Manager of the Year Nominees. (Nominees in the Allocation and Alternatives categories will be revealed on Thursday and Friday, respectively. All winners will be announced on Jan. 15.)

Michelle Canavan Ward is a senior fund analyst on the active funds research team with Morningstar.

It was a challenging environment for fixed-income funds in 2013, as the broad-market benchmark Barclays U.S. Aggregate Bond Index lost money for the first time in more than 15 years. Federal Chairman Ben Bernanke rattled the bond markets with his announcement in May suggesting that the Fed would start to taper its purchases of bonds sooner than expected. That prospect sent ripples throughout the bond market. Investors’ fear over rising interest rates was realized as all but the shortest-maturity U.S. Treasury yields rose after bottoming for the year at the beginning of May. For instance, the 10-year Treasury, which began the year at 1.86%, climbed to nearly 3% by year-end. Many fixed-income sectors took it on the chin during the summer months of 2013 as a result, particularly longer-duration U.S. Treasuries, U.S. Treasury Inflation-Protected Securities, and emerging-markets debt, and haven't fully recovered. Meanwhile, against the backdrop of a generally improving housing market and broad economy, managers who were willing to take credit risk via high-yield corporates, nonagency mortgage-backed securities, and bank loans, for example, were rewarded. Several of this year's contenders also saw a long-held conservative stance toward interest-rate risk ultimately vindicated.

Although a strong showing in 2013 is an important criterion in selecting our nominees, we also want to recognize managers who have delivered superior long-term returns with sound strategies that continue to earn our analysts' confidence. As a result, all nominees have earned a Morningstar Analyst Rating of Bronze, Silver, or Gold, indicating that Morningstar's analysts think the funds will outperform their peers on a risk-adjusted basis over a full market cycle. This year's nominees for Fixed-Income Fund Manager of the Year are as follows:

Dodge & Cox Investment Policy Committee,  Dodge & Cox Income  
2013 Return: 0.6%
Morningstar Category Rank (Percentile): 8

Dodge & Cox's seasoned 10-member investment policy committee has earned a nomination for Dodge & Cox Income’s 0.6% gain during 2013's challenging bond market conditions. While modest in absolute terms, it looks impressive compared with its Barclays Aggregate US Bond benchmark's 2% loss and tops the average intermediate-term bond fund by more than 2 percentage points. This fund's management team works off a three- to five-year investment horizon, and its patience with a number of long-term themes positioned the fund well for 2013's rocky bond markets. The team has run the portfolio with a relatively muted interest-rate profile in recent years, for example, and the fund went into 2013 with a 3.7 year duration, well short of its Barclays Aggregate US Bond benchmark and category norms. That caution helped when long-term Treasury yields spiked in mid-2013. Other positives included the fund's long-standing and substantial overweighting to corporates and, in particular, its preference for financial names.

Over longer periods of time, the fund has also drummed up an impressive track record. Its trailing returns through Dec. 31 all land in the best third or better of the intermediate-term bond category, and it has also stood out on a volatility-adjusted basis. A substantial corporate stake, including roughly 11% in high-yield, leaves it exposed if the economy were to weaken significantly, but the fund's stable and long-tenured investment team and thoughtful investment process bode well for its long-term prospects.

Dan Fuss, Matthew Eagan, and Elaine Stokes,  Loomis Sayles Bond
2013 Return: 5.5%
Morningstar Category Rank (Percentile): 16

Lead manager Dan Fuss and his team are no strangers to Fund Manager of the Year accolades: The group has been nominated multiple times in the past, with Fuss taking home the award in 1995 and the whole team winning in 2009. The team has earned another nod for 2013 thanks to Loomis Sayles Bond’s 5.5% gain, which landed ahead of more than 80% of its multisector bond competitors’ and outpaced its average peer's by 3.7 percentage points. In recent years, the team has increasingly positioned the portfolio for a period of gradually rising interest rates and an improving economy. To that end, the team socked roughly a fifth of the portfolio in high-yield bonds, while building a historically high 17% stake in a mix of common stock, convertibles, and convertible preferreds. A stake in Ireland, a contrarian bet when the position was initiated in 2010, continued to boost returns until it was sold during the year; a sizable position in the debt of financial companies was another area of strength.

It is not surprising to see this fund flourish in an environment that favors credit and equity risk over interest-rate risk, but its long-term record is similarly strong. Over the trailing 10 years, the fund has returned 7.7% on an annualized basis, a record that ranks in the top decile of the category. The fund's meaningful credit, currency, and, more recently, equity risk leaves it vulnerable to sharp declines in periods of market stress, and its relatively high historical standard deviation means the fund is not for the faint of heart. But for those patient investors with a high tolerance for risk, it has rewarded fundholders handsomely over the years.

Tad Rivelle, Stephen Kane, and Laird Landmann,  Metropolitan West Total Return  
2013 Return: 0.2%
Morningstar Category Rank (Percentile): 11

TCW/MetWest's fixed-income CIO Tad Rivelle and team won the Fixed-Income Fund Manager of the Year Award in 2005 and have been nominated multiple times in the past, including for Fund Manager of the Decade in 2009. At first glance, a 0.2% gain for 2013 hardly looks like something to cheer about, but it's an impressive feat when compared with broad fixed-income market indexes and the fund's intermediate-term bond competitors. The managers have long maintained a defensive stance toward interest-rate risk here, a bet that finally paid off in 2013. That positioning resulted in a rare slump for the fund in 2011 when Treasury yields dropped for much of that year and a flight to quality weighed on the fund’s relatively aggressive stance. But with an eye on the long term and a belief that investors were not being compensated at the prices offered to take interest-rate risk, the team held tight, maintaining a relatively short duration and very modest allocation to U.S. Treasuries. A sizable stake in nonagency residential mortgage-backed securities, a corner of the market where the team has cultivated significant expertise and resources, also gave a big boost to performance thanks to an improving U.S. housing market. 

The managers' methodical approach and value discipline has delivered time and again over the years, resulting in a stellar long-term record that has rewarded investors handsomely. And while they have shown a willingness to take considerable risk when the price has been right, the fund's exceptional long-term record in both absolute and volatility-adjusted terms suggests investors have been well compensated for the fund's above-average volatility.

Dan Ivascyn and Alfred Murata,  PIMCO Income
2013 Return: 4.8%
Morningstar Category Rank (Percentile): 18

Comanagers Dan Ivascyn and Alfred Murata have earned a nomination for an impressive 4.8% gain during 2013. Despite a sizable investment in emerging-markets bonds (19% at the end of April) that were hit hard during the year, a core stake in nonagency mortgage-backed securities gave a huge boost to performance as those securities continued to benefit from an improving housing market. The mortgage effort at PIMCO ranks among the industry's elite and the firm has continued to pour resources into that corner of the market, which paid off for fundholders in 2013. Smaller stakes in investment-grade and high-yield corporate securities, particularly financials, also helped the fund place among the top of the pack.   

The team has also impressed over the long term, setting a high bar for itself with a five-year trailing return well into the multisector-bond category's best quintile, all while delivering on an income mandate that has produced fat yields without returning capital. Meanwhile, the portfolio has displayed levels of volatility comfortably below those of its peers, despite the fund's use of leverage--a tool whose magnitude it has managed adroitly--for most of its existence. In fact, the fund has proved remarkably resilient, even in times of market stress such as the third quarter of 2011 and the summer of 2013. Still, the fund's focus on nonagency mortgage-backed securities comes with noteworthy credit and liquidity risk, which could make it vulnerable to a slowdown or reversal in the U.S. housing recovery.

Mark Vaselkiv,  T. Rowe Price High-Yield  
2013 Return: 9.1% 
Morningstar Category Rank (Percentile): 14

T. Rowe Price veteran Mark Vaselkiv has earned a nomination for his fund's 9.1% gain for 2013. While high yield in general was one of the few bright spots of the fixed-income market, this fund has even stood out relative to peers, topping the typical high-yield fund by more than 2 percentage points. Going into the year, Vaselkiv felt more comfortable taking on additional credit risk over interest-rate risk, swapping out some of the fund's higher-rated (and more rate-sensitive) junk debt for CCC-rated bonds. An above-average stake in the lowest-rated segment of the high-yield market rewarded this fund's investors as those securities generally notched the biggest gains during the year. Perhaps as important is that the fund closed to new investors in April 2012. Against the backdrop of a run-up in high-yield bonds, Vaselkiv argued that closing the fund meant that he didn’t have to participate as heavily in the white-hot market for new issues. He believes the closure has played an integral role in the fund’s recent success.

What's more, the fund's long-term record is a stand out. Through December 2013, the fund's 10-year trailing return of 8.0% surpasses more than 80% of high-yield category peers. The fund’s willingness to load up on the lowest-rated junk debt means it tends to court significant credit risk, which can weigh on returns during periods of market stress. But over time, Vaselkiv has been able to avoid missteps for the most part and fundholders have been well-served with him at the helm. 

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Michelle Canavan Ward, CFA has a position in the following securities mentioned above: PRHYX PRHYX Find out about Morningstar's editorial policies.
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