Wells Capital is making wholesale changes to its corporate bond portfolio that will include nearly quadrupling the number of credits in which it invests and taking quicker steps to sell out-of-favor issues. The abrupt change is an effort to limit the potential damage from any future individual credit blowups. The new strategy is being installed by Wells Capital's recently hired portfolio management team, which wants to prevent a recurrence of the poor performance that hurt their predecessors. At the same time, Graham Allen has resigned from his position as director of global fixed-income at the firm. Allen acknowledges that his responsibilities shifted earlier this year due to poor performance in the firm's core fixed-income portfolio. He says that he had a place at the firm, but decided that after 27 years in the business, it was time for a break. Plans to start his own mutual fund firm, to be called Oracle Investments, are already underway.
Wells Capital will invest in 150-200 credits, rather than the 40-60 it has historically held, and will sharply limit its exposure to any individual credit, says Bob Daviduk, who manages the firm's $22.5 billion in taxable fixed-income. He was brought in earlier this year under Kirk Hartman, the firm's new director of portfolio management (BW, 4/21). All but 30 of the 150-200 names will be weighted within 0.1% of their index. The non-indexed portion will comprise an "alpha" portfolio, where the firm will have an overweight of no greater than 0.5%.
Maintaining a sell discipline is a critical feature of the new strategy, Daviduk says. When an issue drops by five points in price, it will be subjected to a 24-hour review process. "We'll go to the analyst and say, 'figure out what happened, and if you can't tell me why the bond was sold off, we'll get out of it.'" Daviduk says that, "if people had followed that sell discipline for the last three years they'd be way ahead of their indexes."
Money managers are paying increased attention to the issue of diversification in the post-Enron and WorldCom era as investors worry about being overweight should any names go bad, says Dennis Adler, chief corporate bond strategist at Salomon Smith Barney. However, Adler says the practice is more common among insurance companies than total rate of return managers such as Wells Capital. One drawback to the strategy, he says, is that such restrictions can limit a portfolio's upside.
Daviduk says the firm will also choose not to own certain names, no matter how large a portion of the index they may comprise. The overall strategy will be fully in place by the end of the year or early next. He says data from Frank Russell Company and Callan Associates show that beating an index by 40-50 basis points put corporate bond managers in the top 25% over the last five years. "A lot of portfolio managers feel they have to beat the index by 100 basis points, and in trying to hit a home run, they take on imprudent risks," he says.