Total Return Unconstrained

Mark Lindbloom
Portfolio Manager
Travis M. Carr
Product Specialist

Executive Summary

  • TRU benefits from the 45-plus years of Western Asset success managing only fixed-income portfolios and our philosophy of long-term fundamental value and multiple diversified strategies.
  • The TRU strategy remains consistent with our stated goals of seeking superior risk-adjusted total returns, which we believe will be especially important in the uncertain environment we face going forward.
  • We believe the flexibility built into the TRU strategy will continue to make it an attractive fixed-income alternative for Western Asset’s clients.

In this Q&A, Portfolio Manager Mark Lindbloom and Product Specialist Travis M. Carr discuss Western Asset’s Total Return Unconstrained (TRU) strategy, which since its inception in 2004 has sought to maximize total return within defined risk parameters, free from the constraints imposed by traditional benchmarks. Through an actively managed and flexible approach utilizing duration, yield curve, sector, country and currency strategies, TRU seeks to provide attractive risk-adjusted returns versus LIBOR with enhanced diversification benefits compared with traditional fixed-income portfolios. The increased opportunities in global fixed-income sectors, continued market volatility and today’s historically low interest-rate environment make TRU an attractive complement to traditional fixed-income strategies for Western Asset’s clients and investors seeking another diversified source of return.

Q: Why would an investor consider investing in TRU?

TC: An investor would consider TRU because they are seeking attractive risk-adjusted returns in a variety of market environments. Since TRU is not managed versus a benchmark, it is more flexible in terms of overall duration, sector allocations and currencies. Traditional fixed-income strategies are generally long-only, have limited duration flexibility and are tethered to a market-capitalization-weighted benchmark, which is only comprised of a limited number of markets. So, TRU’s flexibility allows us to allocate capital to the most attractive risk-adjusted value opportunities as opposed to relative positioning versus a benchmark. This is in line with Western Asset’s philosophy, which focuses on long-term fundamental value and uses multiple diversified strategies in seeking attractive risk-adjusted returns.

Q: If you don’t have a benchmark, how do you construct a TRU portfolio?

ML: At Western Asset, we define unconstrained fixed-income investing as strategies that are ultimately managed within a pre-determined volatility range. These ranges are used to help keep these strategies within a client’s desired risk and return profile.

Back in 2004—the year of TRU’s inception—we chose a return target of LIBOR plus 200-300 basis points (bps) subject to a 3%-6% volatility range. One of the reasons that we chose those targets was that we thought that investors would find some comfort in a volatility target that approximated the historical volatility of the broad fixed-income market as opposed to a more aggressive unconstrained strategy.

Portfolio construction for TRU follows a similar process to how we design our other broad-based portfolios. Given the flexibility of the strategy, however, we generally have larger exposures to our higher-conviction strategies where our view of valuations differ the most from the markets. Therefore, the sizing of those strategies will vary across different types of portfolios.

Since a volatility range of 3%-6% is central to how we position and size TRU every day, risk estimation and management are critical inputs in maintaining ex-ante portfolio volatility within that range. For example, in managing TRU, we take into account the mix of rates, yield curve, volatility, sectors and currencies to estimate what the overall portfolio volatility will be. We work very closely with our strategy committees and our Risk Management Team to make sure, through a variety of measures, that we’re staying within our target range.

Q: What are your main expected sources of return in TRU?

ML: Historically, when you look at our TRU portfolio, the contribution to returns has generally been a function of 1) active sector rotation, 2) issue selection within those sectors where our analysts globally are choosing the issues that they find most attractive from a valuation and credit point of view and 3) tactical duration and yield curve management. This also depends on the environment we’re in, however. At some point, we could expect duration and yield-curve management to be far more important than the sector rotation and issue selection.

Q: How does Western Asset measure success in the TRU strategy?

ML: Number one, offering attractive risk-adjusted returns over time. Our goal is LIBOR plus 200-300 bps given the volatility range that we’re targeting for TRU portfolios. Second, avoiding negative returns—to get out of the way if you will. That’s something you cannot do in more traditional fixed-income portfolios where duration and sector allocations are more tightly controlled than they are in unconstrained portfolios. For example, if you have a period of rising rates or widening spreads, the flexibility built into the TRU strategy allows you to reduce duration substantially or to get out of sectors that you don’t find particularly attractive. You don’t have that constraint of tracking error relative to a benchmark and you don’t have to be invested in those sectors. Third, if we get into a period of time where rates are rising and traditional fixed-income portfolios and benchmarks have negative returns, we would expect the TRU portfolio, given its flexibility, will generally offer positive returns over reasonable periods of time. Not necessarily day-to-day or week-to-week or month-to-month, but over a market cycle of 3 to 5 years, we would expect to meet our target of LIBOR plus. Fourth, attractive risk-adjusted returns relative to our peer group. Those are a few examples of how we would define success for the clients invested in TRU portfolios.

Q: Is TRU simply a spread product strategy without duration?

ML: No. TRU is meant to be very flexible as the environment changes. If in future years we do see a rise in nominal rates and very good performance out of the spread sectors, to the point that we thought there was a better value in sovereign rates relative to spread sectors, then given the flexibility in this product, we would expect to extend our duration and reduce our spread sector exposure. In such a scenario, TRU could be a positive differentiator relative to more traditional, benchmark-tethered strategies.

Q: Why is TRU attractive now and why will it be attractive in the future?

ML: For most of my 38-year investment career, we’ve been living in a bull market in bonds. We’ve come from Brazil-type rates in the early 1980s to negative, zero or modestly positive rates around the world today. That isn’t a statement to say that the trend is over. It might be or it might not be. We just don’t know and we have to be humble guessing where the bottom in rates might be. We’re in an environment of very low-yielding fixed-income assets around the globe, continued volatility, and where central banks are doing just about everything they can to try to achieve a 2% inflation rate or higher, including pushing governments to increase fiscal spending. Because of all that, we could see some potential changes to this long-term trend of declining rates. With this in mind, we believe the flexibility built into the TRU strategy should continue to make it an attractive fixed-income alternative for our clients.

Q: What are Western Asset’s competitive advantages regarding the TRU strategy?

TC: TRU benefits from the 45-plus years of Western Asset success managing only fixed-income portfolios and our philosophy of long-term fundamental value and multiple diversified strategies. We are one of the truly global fixed-income managers, so TRU benefits from the depth of resources we have across all asset classes. As such, TRU incorporates Western Asset’s proven ability to combine top-down macro views with bottom-up research.

Western Asset has been managing unconstrained portfolios since 1996, and we’re coming up on our 12th anniversary of managing TRU portfolios. The TRU strategy remains consistent with our stated goals of seeking superior risk-adjusted total returns, which we believe will be especially important in the uncertain environment we face going forward.

This paper was originally posted December 2013.

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