Kohli Swaps Landing Fighters to Top Global Bond Funds: Mortgages
William Kohli, the world’s top global bond fund manager, has made daring moves during his career from an early age.
In his first job out of college at Sperry Corp., he helped write one of the first software programs for the Marine Corps to allow its jet fighters to land without the assistance of pilots. From a naval airbase in Vallejo, California, in the early 1980s, with his adrenaline flowing, Kohli used a computer to steer the planes to the ground without crashing.
“There’s nothing like watching an airplane come down and the pilot doesn’t have hands on the controls,” Kohli said. “I’m a fairly unconventional guy. I like the stimulation and the payoff of watching the results of a product performing the way it’s supposed to.”
Now, as co-head of fixed income at Boston-based Putnam Investments LLC, Kohli, 52, displays nail-biting intensity with unorthodox bets. He invests in below investment-grade residential and commercial mortgage-backed securities and debt from Argentina, Greece and Venezuela in his $5.3 billion Putnam Diversified Income Trust fund.
To benefit from rising interest rates, Kohli is one of the few bond managers to shift the duration of his fund to negative from positive. Duration, expressed in years, is a measure of a fund’s sensitivity to interest rates. By going negative, Kohli is boosting protection against rising rates since the fund will increase in value as they go up.
Kohli’s gambles have thrust him to the top of a ranking of 57 global bond fund managers with at least $100 million in assets, according to data compiled by Bloomberg. In the five years ending Dec. 31, his fund produced an annualized return of 16 percent, the data show. And it gained 7.9 percent in 2013, topping all rivals, including Pacific Investment Management Co.’s Foreign Bond Fund (PFORX), which returned less than 1 percent.
The Putnam manager is making the fund more vulnerable than its peers if interest rates decline. And some of his past wagers have produced major losses -- for instance, he increased exposure to investment-grade CMBS during the financial crisis in 2008.
As credit markets seized up, investors were forced to sell even top-rated securities derived on debt tied to everything from skyscrapers, shopping malls and hotels. His fund plunged 36 percent in 2008, trailing 98 percent of his peers. Kohli said the beating reinforced in him the importance of focusing on liquidity risk, not just credit risk.
“While the fund has had flashes of brilliance, at different times, it’s been particularly volatile and risks have reared their head,” Eric Jacobson, a senior fund analyst at Morningstar Inc. in Chicago, said. The research firm gives Kohli’s fund a forward-looking negative rating, which means it’s considered an inferior offering to its peers.
The maverick manager copes with the swings of his fund by doing yoga in a room heated to 105 degrees Fahrenheit (41 degrees Celsius) up to four times a week.
“It’s intense and a great stress reliever with work and when traveling,” Kohli said. “I’ve done it in Tokyo, Paris, London and Atlanta.”
Kohli is optimistic about U.S. real estate in 2014 because he said there’s a low probability of a catastrophic event. In the last 12 months, he’s been scooping up commercial mortgage-backed bonds including those issued before the crisis as the property market continues to stabilize. He holds CMBS arranged in 2005 by Wachovia Corp., which was bought by Wells Fargo & Co. after the lender almost collapsed. The securities are rated the lowest level of investment-grade by Standard & Poor’s and Moody’s Investors Service.
Kohli has made riskier bets with sovereign debt. He bought Greek bonds last year when they were about 35 cents on the dollar. He sees little chance of credit losses on those securities with a Europe-wide objective to get the Greek economy back on track. About 2 percent of his fund is allocated to Greece, the second-highest country allocation after the U.S., according to Putnam’s website.
In emerging markets, Kohli favors debt issued by Argentina, which has annual inflation estimated by private economists at about 27 percent. He also likes securities from Venezuela, which is moving toward devaluing its currency. He picks debt from these nations with maturities of no more than 20 months and yields as high as 20 percent.
David Mussafer, a friend of Kohli’s for about 15 years, said his audaciousness extends to vacations. Mussafer and his family have gone on Kohli-planned trips with his wife and four children to dive in caves in Belize and see the Northern Lights in Iceland.
“He isn’t looking for the tour that everyone has done,” Mussafer, a managing partner at Boston-based private equity firm Advent International Corp., said. “We couldn’t just walk into a cave in Belize with Bill. We had to hike up a mountain for an hour, then swim for 40 minutes through a cave to get to this real Mayan burial site with skulls.”
For excitement closer to home, Kohli likes to paddleboard surf off the coast of Rhode Island when there’s a hurricane raging to the south, producing bigger waves.
Kohli, who moved around the West Coast as a kid with his family, said he’s tried to emulate his father’s out-of-the-box approach to life. Kohli, who is color blind, couldn’t fly Navy jets like his dad. So instead he carved an unusual path in the investing world.
In the mid-1980s, as an MBA student at the University of California, Berkeley, he went to a brown bag lunch about the mutual-fund industry. He was one of the only students to attend.
While working on his degree, as most of his peers were flocking to investment banks, Kohli became the first business-school intern hired by money manager Franklin Resources Inc. At Franklin, he ran a global bond fund and said he was the first mutual-fund investor to buy securities issued by Mexico after it defaulted and restructured its debt. After eight years at San Mateo, California-based Franklin he left for Putnam in 1994.
Today, Kohli and his team of about 50 people, including four co-managers, run the Putnam fund. It attracted $1.6 billion last year through Nov. 30, according to Morningstar. The fund has benefited from investor demand for flexible bond funds which place bets across a broad array of fixed-income assets to protect against the impact of higher interest rates.
The year after Kohli’s 2008 pummeling, he started buying residential mortgage-backed securities that don’t have the backing of the U.S. government at 35 cents or 40 cents on the dollar. The non-agency securities have jumped in value as housing recovered and defaults dropped. Home prices in 20 U.S. cities rose 13.6 percent in October from a year earlier, the biggest gain since February 2006, according to the S&P/Case-Shiller index.
Kohli hedges those securities with collateralized mortgage obligations, or packages of home-loan bonds guaranteed by Fannie Mae and Freddie Mac or Ginnie Mae. Kohli focuses mostly on interest-only securities, whose performance is tied to interest payments on pools of mortgages.
If the housing market stays flat or declines, these securities may perform well because fewer homeowners are able to refinance and lower their interest payments. As interest rates rise, homeowners are also less likely to refinance.
Kohli’s fund has benefited from the jump in mortgage rates after Federal Reserve Chairman Ben S. Bernanke signaled last year it would begin tapering its unprecedented bond-purchasing program. His replacement, Janet Yellen, was confirmed yesterday by the Senate.
The average rate for a 30-year fixed mortgage climbed to 4.53 percent earlier this month from a near-record low of 3.35 percent in early May. The Mortgage Bankers Association’s weekly index of refinance applications dropped 59 percent in the week ended on Dec. 20 from January 2009.
“If I hold those two sectors together, I’m essentially getting excess yield and immunizing myself against any specific housing outcome,” said Kohli.
In a long-term move, Kohli has used derivatives to gradually shift the average duration of his fund to negative. He sells Treasury futures and buys interest-rate swaps, which generally exchange fixed-rate interest payments for floating-rate ones, to minimize interest-rate risk. As rates rise, swaps perform well as the floating rate an investor receives goes up, offsetting the fixed rate which stays flat.
Kohli’s negative duration makes him an outlier. His fund is among the fewer than 1 percent of the 1,351 U.S. bond funds that have provided duration information to Morningstar that are negative, according to the research firm.
Before the financial crisis, the duration of Kohli’s Putnam fund was about 5 years. He shrank the duration to one year by 2010 and took it negative for the first time in 2011.
The strategy temporarily backfired, when investors sought the safety of Treasuries during the European sovereign debt crisis. His fund lost 3.2 percent in 2011 as the most widely used fixed-income benchmark, the Barclays U.S. Aggregate Index, increased 7.9 percent.
As of Sept. 30, he had increased the negative duration to 2.34 years on the expectation of higher interest rates. The Fed said Dec. 18 it would cut its monthly bond purchases to $75 billion from $85 billion starting this month.
Keeping duration negative for extended stretches may cost a fund by missing out on much of the income an investor gets from having a long position in bonds, Morningstar’s Jacobson said.
For the past 25 years, anytime there was a stressful situation at work, Kohli said he would tell his wife they should buy a bookstore. Three years ago, they purchased Wellesley Books in their hometown of Wellesley, Massachusetts, even as independent sellers struggle.
He’s passionate about books -- his favorite authors include Ian McEwan and Peter Carey. Kohli often works the register on Sundays and started a book club for men who talk about novels over beer, single malt Scotch and wine in the basement of the store.
“I would file that in the unconventional side,” Kohli said.
Top Five Global Bond Funds
These managers, with at least $100 million in assets, had the highest returns over five years ending Dec. 31.
GuideStone Global Bond Fund, Pasadena, California, and Boston Manager: Subadvised by Western Asset Management Co. and Loomis Sayles & Co. Return: 12.4 percent
Putnam Global Income Trust, Boston Managers: William Kohli, Michael Atkin, Kevin Murphy and Michael Salm Return: 11.9 percent
Templeton Global Total Return Fund, San Mateo, California Managers: Michael Hasenstab and Sonal Desai Return: 11.7 percent
MainStay Unconstrained Bond Fund, New York Managers: Dan Roberts, Michael Kimble, Taylor Wagenseil and Louis Cohen Return: 11.2 percent
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