Tuesday, May 21, 2013

The Lord Abbett Short Duration Bond Fund

On May 7, we spoke with Don Annino, a portfolio specialist at Lord Abbett about the Short Duration Income Fund.  The fund attempts to maximize return by investing across all bond market sectors including investment grade and high yield corporates, mortgage, government, and asset backed securities while keeping the fund’s duration (a measure of interest rate sensitivity) within a 1-3 year range.  Prior to 2007, the fund could only invest in government backed securities. A mandate change in 2007 gave the portfolio managers the flexibility to invest in these other areas of the bond market. The two lead portfolio managers on the fund, Robert Lee and Andrew O’Brien, have been working together for twelve years. 

Since 2009, the fund has seen average returns of around 4.5%, and has consistently outperformed Barclay’s 1-3 year Government/Credit Bond Index.

The Short Duration Fund has seen a huge influx of cash recently and now has assets that surpass $30 billion.  Even with assets at these levels, management insists that they still have a lot of capacity.

The fund has few restrictions on where in the bond market it can invest, going wherever it finds the best relative value.  Currently the managers are more focused on interest rate risk than credit risk.  That has led them to invest 35.5% of the portfolio in Investment Grade Corporate bonds. High yield bonds are 14.5% of the portfolio, down from 25% in 2010.  They think corporates could weather a recession and find that most companies will not face significant refinancing needs until 2015.

Commercial Mortgage-Backed Securities make up 28% of the portfolio, down from 50% in 2008, an all-time high for the fund. These CMBS include loans on retail, office space and hotels. Growth in these sectors is tied to economy which continues to slowly recover. In addition, 10.2% is invested in Agency Mortgage-Backs, most of which are 5 year ARMs. Another 9% is invested in Asset Backed Securities (ABS), almost all with AAA ratings. Assets backing these bonds include autos, credit cards, and a few student loans, maturities are typically less than one year and the issues are very liquid. The Fund has only 1% in cash (it has ranged from -1 to 2%) but between the liquid ABS and the fund’s line of credit they believe they have ample liquidity.

Going forward, Lord Abbett sees slow growth- around 2% GDP. They are encouraged by the housing market and discouraged by unemployment. They expect the Fed to continue its highly accommodative monetary policy.  Consistent with the structure of the portfolio, they believe that there is more risk of a major move in rates rather than a collapse in credit. Management points out a number of potential risks that could possibly cause losses similar to those of 2008. The biggest risk is another scare that the Euro Zone will break apart. In addition, issues could also arise if China sees another slowdown of their economy (with growth slowing down to less than 6%).  At some point the continued increase of the Federal Reserve’s balance sheet could also cause the markets substantial concern.

We have started using this fund relatively recently in some client portfolios.  After our conversation, we remain very comfortable with managements approach. The fund has been very successful and has seen a huge inflow of assets recently. Still, the management team believes they have tremendous capacity as they operate in a very large and liquid part of the bond market.

Assistance on this post was provided by Ethan Xu 

(Harvest Financial Partners owns this fund in client portfolios. The principals of Harvest Financial Partners own this fund in their personal portfolios.  Positions may change at any time)