Rocket science? Beliefs fuel bond investment strategy

Let’s face it, a set of investment beliefs is only as good as an investor’s willingness and ability to act. 

You may believe that Elon Musk and Richard Branson are going to offer economy-class flights to new final frontiers, but are you ready to buy a ticket – or invest capital in an industry that relies on explosions to propel us beyond earth’s atmosphere?

Russell’s Global CIO Jeff Hussey has articulated our firm’s Strategic Beliefs in presentations and in meetings with clients. This philosophy is more down-to-earth than those of Musk or Branson, but we’re talking about investing real people’s retirement assets, after all.

To illustrate, let’s take a look at how our beliefs drive implementation of bond investment strategy. This story takes place right here on earth and in the trenches of Russell’s $60 billion fixed income asset class. As we entered 2014, we believed our selection of multiple active managers was poised to provide an appropriate level of risk and return, especially given the ongoing intrigue surrounding economic growth rates and inflation, globally.

One of our strategic beliefs for fixed income says that, over the course of a full market cycle, we believe in credit risk. In other words, we generally feel corporate bonds that take on credit risk are more likely to produce higher returns by exploiting the spread beyond what comparable government securities offer. Okay, it’s not rocket science, but it’s a consistent belief on our part.

So, while we liked our manager selections going into 2014, we also saw an opportunity to add an extra factor of both risk and diversification to our portfolio. And we felt we could do this without diluting or upsetting the balance of manager diversification we had already achieved. In fact, in this case 92% of our portfolio would remain fully invested in our core multi-manager mix; approximately 8% would be subject to custom factor exposures as a complement to our managers’ exposures.

Think of it this way: We felt we had built a proper spacecraft. In our view, it was both powerful and safe, but we saw an opportunity to customize the fuel mixture in order to improve both our safety margin (diversification) and our speed (investor outcomes).

In this case, part of the adjustment came with currency exposure. Since the market was later in the credit cycle, we increased our exposure to the value currency factor – currencies that were being discounted by the market at large. This allowed us to prudently add active risk to the portfolio while also helping to improve the diversification overall.

We were adhering to our beliefs, relying on multiple managers and using our in-house portfolio management team to add prudent risk and diversification to the mix. In today’s market environment, this was essentially us adding active management via use of particular investment factors. We believed in our offense, but we saw an opportunity to add a defensive capability because we could invest in value-oriented currencies beyond what our managers were providing in their own bond strategies.

In portfolio management, as in space travel, everything depends on the landing. In this case, our in-house implemented factor exposures allowed us to keep pace with peer managers for much of 2014, then our added factors paid off by adding about 25 basis points in excess return to the portfolio for the fourth quarter.1 This is not always the case; sometimes the landing is rough, and the added factor diversification does not pay off the way we hope. We know that, but we still consider tweaking the fuel mixture. We know patience is required, and that was ultimately rewarding in late 2014 in this particular example.

The point is, our strategic beliefs allow us to explore these opportunities and look for ways to expand the inherent power of multi-manager investing. It’s the difference between the last decade’s multi-manager investment vehicles and those of the future – active multi-asset vehicles.  Now who’s ready for the next final frontier?

1 Peers are as measured by the Morningstar Intermediate Bond Universe as of December 31, 2014.