Value Tax-Aware Opportunistic
The Value Tax-Aware Opportunistic strategy seeks to maximize after-tax total return.
The strategy uses a value-driven approach and seeks to maximize after-tax total return by investing in a portfolio of primarily investment grade, fixed income securities. The strategy seeks to add value by capitalizing on imbalances in the relationships among sectors and individual bonds, spanning both tax-exempt municipals and US-dollar denominated taxable bonds. We believe that investing in undervalued sectors and bonds and selling expensive ones using an after-tax relative value assessment can maximize returns for investors.
The investment universe for this strategy considers both tax-exempt municipal bonds as well as US dollar-denominated taxable fixed income securities, including governments, corporate bonds, asset backed securities and sovereign and supranational entities and taxable municipals. The strategy uses a scenario-driven analysis to determine the appropriate level of interest rate risk where the main objective is to offset any principal loss over a three-year time horizon.
The US Multi-Sector Fixed Income team is made up of several New York based portfolio managers dedicated to value-oriented fixed income investing, and are supported by an experienced team of more than 30 global credit analysts, with geographical and industry expertise.
While municipal bonds are the traditional fixed income choice for most US taxpayers, our strategy will also invest in taxable bonds when we believe they are undervalued. Varying allocations between tax-exempt and taxable securities is a defining characteristic of our management style. When we believe tax-exempt bonds are undervalued, we increase portfolio share, and conversely, when we believe tax-exempts are expensive, we de-emphasize them and focus on areas where we can find value. When investing in taxable bonds, we compare the value of owning Treasuries relative to credits.
Major imbalances exist in the relationships between individual bonds or sectors, and are caused by the ebb and flow of supply and demand, as well as sentiment and positioning. These are far more powerful factors in driving valuations than changes in fundamentals of investment-grade bonds. We believe these market anomalies can be exploited to generate returns.
We believe that undervalued bonds will outperform overvalued bonds and our strategy is focused on purchasing bonds that we believe are undervalued. When, in our view, bonds become fully priced, we seek to exchange them for better valued issues.
Our investment process for tax-aware portfolios focuses on our core principles of value and discipline. In constructing portfolios, there are three parallel processes at work, and a system of checks and balances to ensure portfolio objectives are met:
- Adherence to the desired overall portfolio characteristics
- Value assessment
- Portfolio construction
Adherence to the desired overall portfolio characteristics
The investment team determines the desired general characteristics for the portfolio. Principal factors include: interest rate duration, spread duration, yield, roll, convexity and yield curve positioning. Depending on the duration of the portfolio and applicable tax rates, different emphasis may be placed on each of the individual factors. The firm believes analytical tools that apply to taxable bonds do not work properly on tax-exempt bonds and instead has developed and uses proprietary analytics, including a Net Implied Tax Rate that indicates when we think municipals offer value.
The strategy’s defining characteristic is crossover management, or the ability to allocate between taxable and tax-exempt municipal bonds. Relative value analysis across tax-exempt and taxable sectors is used to position and concentrate portfolios in what we view as the most undervalued securities within the most undervalued sectors. We analyze historical spread relationships among sectors and securities and also look at dynamics of supply and demand, and sentiment and positioning driving valuations.
In selecting among the three broad sectors (tax-exempt municipals, Treasuries and credits), we closely analyze the historical relationships among the sectors to understand what is driving the relative valuations. Broad sector and industry research help us try to determine whether an area of the market is under pressure for legitimate reasons or is truly under or over priced relative to fundamentals. The portfolio manager’s direct interaction with the market is critical in judging the supply, demand and/or other technical and temporary factors that drive price anomalies in the market, as well as the implications on after-tax yield.
Successful portfolio construction is the result of properly managing and integrating the desired portfolio characteristics and the more subjective relative value judgments. At times, the bonds determined to be cheapest in the market may be out of line with generally appropriate portfolio characteristics. There are always trade-offs and compromises between structure and value. The greater a particular portfolio’s constraints and the higher its capital gains rate, the more we consider structure; the greater the flexibility of a portfolio to operate without constraints, the more we consider value. When there are portfolio design conflicts, value generally receives more weight than strict adherence to structure.
- Primarily invests in tax-exempt bonds but will invest in taxable bonds when they are undervalued
- Portfolio composition is based on assessment of relative value of securities and sectors in the fixed income universe
- Robust scenario analysis to evaluate portfolio construction and performance using various interest rate scenarios
- Emphasize liquidity and credit quality—provides ability to act quickly or stay in positions longer term
- Effectively balance relative value decisions with specific client capital gain/loss considerations
- Crossover decision and sector allocation is the key to generating return