Rivelle Beats Gross as Mortgages Pay Off: Riskless Return
Tad Rivelle decided in 2008 that prices for some bonds got so low after Bear Stearns Cos. and Lehman Brothers Holdings Inc. collapsed that they made sense only if the U.S. was headed into another Great Depression.
Convinced it wasn’t, he bought bank debt and mortgages not backed by the government in his $23.7 billion Metropolitan West Total Return Bond Fund (MWTIX), a move that paid off in 2009 and 2010 as those bonds rebounded with the economy. That helped Rivelle beat Bill Gross and the managers of all other large intermediate-term bond funds over the past five years when adjusting for volatility, according to the BLOOMBERG RISKLESS RETURN RANKING.
“We were willing to stand up and say the world is still a going concern and it is time to go long on certain assets,” Rivelle said in a telephone interview from Los Angeles, where Met West parent TCW Group Inc. is based.
Rivelle, who oversees about $81 billion as TCW’s chief investment officer of fixed income, and his co-managers are value hunters. They buy securities they see as bargains based on long-term fundamentals and sell them when prospects for more gains dim. The managers reduced such speculative holdings as high-yield debt this year because the bonds look expensive after doubling since March 2009. They added to safer securities including Treasuries and higher-quality mortgages.
Rivelle, 51,Stephen Kane, 50, andLaird Landmann, 48, have worked together for 17 years and run the Met West fund since it was created in 1997. Earlier, all three were employed at Gross’s Newport Beach, California-based Pacific Investment Management Co., home of the Pimco Total Return Fund (PTTRX), the world’s largest mutual fund.
The Pimco experience, Kane said, taught them the importance of sticking with a disciplined process that can consistently produce alpha, or market-beating performance. The managers pursue that goal differently from their Pimco mentors.
“They are top down and we are bottom up,” Kane said. Gross and his team running the $285 billion Total Return Fund have flourished by making big-picture judgments about the economy and interest rates, he said. The Met West group focuses on bond market segments and individual securities that look mispriced.
Both funds rank in the top 2 percent of the intermediate bond category over the past 15 years, according to Chicago-based research firm Morningstar Inc. (MORN)
“Over time the two funds stand out,” Landmann said.
Met West Total Return gained 12 percent, adjusted for price swings, in the five years ended Nov. 30, according to data compiled by Bloomberg. That was the best of 21 intermediate-term bond funds that buy government and corporate debt and have at least $2 billion in assets. The fund had the greatest total return with about average volatility.
The Pimco Total Return Fund returned 11 percent and ranked third adjusted for risk, blending the second-best absolute return with the eighth-highest volatility.
The $5.7 billion Janus Flexible Bond (JAFIX) Fund had a risk-adjusted return of 11 percent, placing second, slightly ahead of Pimco.
The risk-adjusted return, which isn’t annualized, is calculated by dividing total return by volatility, or the degree of daily price variation, giving a measure of income per unit of risk. A higher volatility means the price of an asset can swing dramatically in a short period, increasing the potential for unexpected losses.
Rivelle’s decision to buy mortgage and financial securities during the 2008 crisis illustrates his approach to finding value. He increased non-agency mortgages to 12 percent of assets as of June 30, 2008, from 9.5 percent the prior quarter, after Bear Stearns’ collapse. He lifted financial bonds to 19 percent on June 30, 2009, from 15 percent on Sept. 30, 2008, regulatory filings show.
The logic was simple, Rivelle said. Once Lehman Brothers failed in September 2008, triggering a worldwide freeze of credit markets, it was clear the U.S. government wouldn’t allow another major bank to shut down.
“The aftershocks would have been devastating,” he said. “Policy makers put their arms around those banks.”
Bank bonds gained 18 percent in 2009 and 9 percent the next year, according to Bank of America Merrill Lynch indexes, helping the Met West fund outperform most peers. The debt advanced 15 percent this year through Nov. 30.
The fund’s bet on non-agency mortgages followed a similar pattern. The debt plunged in 2008 as the housing crisis worsened and investors dumped speculative assets. Rivelle bought a blend of subprime, or below-investment-grade, mortgages; Alt-A loans, which don’t require the usual amount of documentation; and prime mortgages, which meet stringent underwriting guidelines.
“People were saying these securities were too complex and that no one knew what was in them,” Landmann said. Met West had extensively researched the loans being packaged into mortgage-backed securities, concluding that defaults would be fewer and recoveries to investors greater than the market was anticipating.
Rivelle’s fund began adding to non-agency debt too early in hindsight because prices kept falling late in 2008, Landmann said. The debt rallied when the economy recovered in 2009, climbing 34 percent, Met West data show. It gained 26 percent in 2010, declined 7 percent in 2011 and returned 28 percent through Nov. 30 this year as the housing market bounced back.
“They have been preaching that non-agency represented the best value in the marketplace and it has come true,” Patrick Ryan, portfolio manager with Madison Asset Management in Madison, Wisconsin, said in a telephone interview. The firm, which oversees $16 billion, owns shares in the Met West fund.
Mortgages hurt the fund in 2011, Rivelle said, when concerns about the European sovereign crisis and a political standoff over raising the U.S. debt ceiling prompted investors to flee risky assets. The fund returned 5.2 percent last year, trailing 59 percent of peers, according to data compiled by Bloomberg.
“We were pretty calm about it,” said Rivelle, who used the dip in prices to buy more non-agency mortgages, boosting them to 19 percent of the fund as of March 31 from 16 percent a year earlier, company data show.
Rivelle built up his non-agency stake gradually in 2009, 2010 and 2011. The incremental strategy mitigates risk and smooths out results over time, and it’s impossible to know precisely when prices for any group of bonds have reached a peak or a bottom, Rivelle said.
“Our approach lends sanity to the process and is understandable to investors,” he said.
The fund’s holdings of U.S. Treasuries more than doubled to 21 percent of assets in this year’s first nine months, company data show. High-yield bonds dropped to 4.9 percent from 6.2 percent.
The managers have also made changes in their non-agency holdings, shifting into higher-rated mortgages, Miriam Sjoblom, a Morningstar analyst, wrote in a note published last month.
“A lot of the juice has been squeezed out,” Sjoblom said in a telephone interview. “It’s going to be difficult for this fund and others to outperform the way they have,” she said, referring to the rally that has resulted in the narrowing of yield spreads across a range of bond categories.
She described the fund’s position as “less aggressive” than in the past. “They take risk but they make sure they get paid for it,” Sjoblom said.
The moves are based in part on Rivelle’s view of the dangers still posed by the European debt crisis and the possibility the U.S. Congress and President Barack Obama won’t be able to avert the $607 billion in automatic tax increases and spending cuts, dubbed the fiscal cliff, set for January.
Rivelle expects the U.S. economic recovery to stay sluggish, with growth of about 1.5 percent to 2 percent a year. Economists surveyed by Bloomberg expect the economy to expand 2 percent next year, based on data from 80 respondents.
“At that rate of growth, risky assets are a bit expensive,” Rivelle said. “They may not be grotesque, but they are stretched.”
The spread of junk bond yields above Treasuries has shrunk to less than 6 percentage points from more than 17 in March 2009, Bank of America Merrill Lynch indexes show. The bonds have doubled in value over that time.
It made sense for the managers to “take a little bit of risk off the table,” said Madison Asset’s Ryan. “There is so little value in the fixed-income markets. You are playing with fire at this point.”
The fund has topped 97 percent of rivals this year in total return, according to data compiled by Bloomberg, as the managers switched direction. Landmann said the rally in riskier assets that drove the fund’s results for the past four years may have run its course.
“That is frustrating for investors,” he said. “They want to know what the next great thing is. The fact is value has been taken out of the market and we need to be conservative.”
As Rivelle put it, “We are no longer being paid to underwrite risk.”
To contact the editor responsible for this story: Christian Baumgaertel at firstname.lastname@example.org