Often, this can mean a relative overweight to the various spread sectors within the index, as well as selected typically higher-yielding or more cheaply valued “plus” sectors, including high yield, bank loans, collateralized loan obligations (CLOs), emerging market, high yield and non-US-dollar-denominated securities. During periods that call for more defensive positioning, the strategy generally adopts a higher-quality, more benchmark-like posture, which may include overweight positioning to the US government sector and potentially agency mortgage-backed securities as a higher-yielding proxy for the government market. A challenge lies in determining where to deploy capital at any given time for the desired mix of portfolio quality, liquidity and price transparency. As such, our investment process begins with a top-down assessment of the global macroeconomic environment and capital market drivers—a view that we use to determine sector, security, yield curve and duration positions.

With this nimble approach, we believe the Loomis Sayles Core Plus Fixed Income strategy can achieve strong returns through a range of economic and market environments. 

The Importance of a Macro View

For us to confidently position the portfolio, we must first analyze the macroeconomic themes shaping the investment landscape. Drawing on Loomis Sayles’ deep macroeconomic and sovereign research capabilities, we continuously assess key global macro factors such as GDP growth, monetary and fiscal policy, inflation, supply/demand dynamics of government bond markets, credit availability and politics, which are typically driven by the world’s major developed economies. Our view of the overall global credit cycle helps us determine a balance between our goals of return maximization and capital preservation and, accordingly, how to position the portfolio relative to the benchmark (e.g., up or down in quality, liquidity and price transparency).

While the US economy is often a major driver of the global economic cycle, other major developed and emerging markets will often play a significant role in the global credit cycle. Additionally, the various economies across the globe do not necessarily progress through the cycle in lockstep. We believe our ability to identify “mini cycles” and assess credit conditions in individual economies is critical. We benefit from the insights of our macro strategists, our credit research analysts across the globe and our sovereign analysts, whose knowledge of local markets helps us pinpoint where opportunities and risks may exist.

Tactical Sector Allocation 

Once our macro strategies team has identified credit cycle themes, tactical use of sectors—including out-of-benchmark exposure—helps us to target opportunities and portfolio themes. The strategy has the flexibility to invest up to 20% in high yield and up to 10% in non-dollar investments. Investment grade CLOs, dollar-pay emerging markets debt and TIPS (Treasury inflation-protected securities) are additional examples of out-of-benchmark security types.

When making sector allocations we are mindful of a cycle’s idiosyncrasies: an effective strategy for one period of credit repair, for example, may not be optimal during the next phase of credit repair. We may tilt toward, or away from, specific industries based on the distinct drivers of the current credit cycle.

For example, in 2008 we tilted away from industries with exposure to housing, including banks, homebuilders and home improvement retailers. In 2021 and 2022, we tilted toward industries leveraged to reopening economies and the phasing out of pandemic-induced lockdowns, such as autos, airlines and hotels. To make informed decisions, we draw on our own experience and firm resources, including specialized sector teams (asset class strategy groups comprised of portfolio managers, research analysts and traders). We then implement our sector strategy through fundamental, bottom-up security selection. In partnership with Loomis Sayles’ credit, sovereign and securitized research analysts, we look to identify disconnects between market pricing and intrinsic value, and determine appropriate position sizes based on relative valuation, issuer volatility and liquidity. 

Plus Sectors: The Tool Kit  

Though plus sectors are often thought of as increased risk/reward areas, we think these sectors can sometimes help reduce portfolio risk. Examples of possible risk diversifiers include TIPS (inflation risk), defensive currencies (e.g., the Japanese yen, the Swiss franc, euro) and floating-rate securities during periods of rising rates (bank loans, CLOs). Overly constrained mandates can force managers to take less attractive positions because of limited flexibility, thereby introducing unintended risk into a portfolio. Likewise, overly flexible mandates biased to reach for yield may introduce too much tracking error and deliver inconsistent returns. We consider a broad opportunity set, but in the context of where we are in the credit cycle and whether we think valuations are compensating us for a higher potential return per unit of risk. Allocations to plus sectors, detailed in the chart below, have averaged 25% of the strategy’s market value since 31 March 2006.¹

Risk Management  

When managing a benchmark-aware strategy that seeks to preserve principal in adverse markets and add excess return in stable-to-improving markets, we believe risk control and downside mitigation are paramount. Relative and absolute risks are monitored continuously, and our ability to position similar to, or different from, the benchmark is central to risk management efforts. While we do not manage to tracking error, we are mindful of the benchmark and tend to only add to tracking error when we feel we are being compensated to do so. The strategy typically targets a minimum 25% allocation to the US government sector. This positioning helps deliver a source of liquidity and also provides a directional link to interest rate movements. Changes in interest rates inform how we manage portfolio duration and yield curve exposure, which we find especially important when the Federal Reserve is very active. When we believe interest rates are approaching a peak and may begin to decline, we typically increase Treasury contribution to duration. In contrast, when rates are too low and are likely to rise, we often decrease Treasury contribution to duration, use TIPS as a substitute for nominal US Treasurys and/or can utilize more floating-rate instruments to shorten duration.

In volatile environments, or late expansion environments when the risk of moving into downturn is higher than normal, we typically favor high-quality, more liquid government securities. During periods of economic repair and recovery, we tend to favor spread sectors that typically offer higher yield advantage per unit of risk. We are mindful of traditional risk measures and historic correlations between asset classes but recognize that at inflection points in the credit cycle, overreliance on backward-looking data can lead to poor decision making. We regularly test our portfolio with forward-looking scenario analysis tools to form a more nuanced and dynamic view of risks to the portfolio and to frame discussions regarding potential positioning changes.

The chart below shows the strategy’s three-year rolling excess return and tracking error through the different phases of the credit cycle. 

Conclusion  

Today’s ever-evolving credit cycles and complex global markets require flexibility. Our benchmark-aware, research-intensive investment style combines macroeconomic insight, changing tactical allocations and security-specific expertise to help meet this need. As a portfolio management team, we have managed through multiple credit cycles and have experienced the dynamic behavior of bond duration, yield curves, currencies and sectors. Drawing on this experience and Loomis Sayles’ research arsenal, we seek to populate the portfolio with what we believe are the best ideas for each distinct market environment and strive to deliver principal preservation and solid risk-adjusted return to our investors.