Managing bonds...

A couple of blogs back I mentioned that treasuries as a subset of the fixed income asset class was one of the rare investments to generate a positive return in 2008. With the crisis in full swing, correlations among asset classes shot up, dragging almost all investments into deep negative territory. The unprecedented rally in treasuries was a sort of a knee jerk reaction to the perception of greater risk in the markets. Panicked and distraught investors sought the safety of the federal government to protect what was left of their rapidly diminishing wealth.
As mentioned in our recent Review & Outlook publication, our fixed income strategy, which was implemented in mid 2007 involved overweighting treasuries and other government securities at the expense of others such as corporates, emerging market, high yield etc. This decision resulted from the observation at the time that spreads in other fixed income markets were just too tight to justify the "greater" risk. Corporate bonds, for example, although generating higher yields, were just not worth the additional risk. This strategy of ours remained pretty much intact throughout 2008, with the exception of a few minor changes such as shortening durations and reducing corporate bond exposure further.
As a result of this strategy, the fixed income segment of our portfolio generated a stellar total return of 7.7% for 2008. This return is adjusted for costs including currency hedging operations. With hindsight, the positive return provided yet another example of the importance of diversification, helping to absorb some of the losses in the other asset classes. It also showed how a sound strategy combined with a disciplined approach can pay off over time.
What we didn't really expect, however, was how much better our fixed income strategy performance would turn out to be when compared to a peer group. We tapped into Bloomberg's database to generate a peer group of funds with the same characteristics and constraints as our bond strategy. The filter generated a list of 8 funds by various institutions with performances that ranged from -5.94 to 4.62%. These results put our bond strategy performance at the 100 percentile, with a 308 basis points outperformance to the best performer in the peer group.
The results also highlights an important point that was made by El-Erian, CEO and Co-CIO of PIMCO, which was that 2008 has shown us that product selection may be as important, if not more important, then the weight attributed to the asset class. Food for thought!