The objective of the Transamerica Investment Management, LLC's (TIM) Core (Aggregate) Fixed Income product is to achieve superior returns relative to peers and benchmarks such as the Lehman Aggregate Index over a full market cycle.
Transamerica Investment Management, LLC's (TIM) Core (Aggregate) Fixed Income portfolio management style uses fundamental and credit research to capitalize on mis-valuations in the least efficient portions of the fixed income markets. Accordingly, security selection, industry sector and asset weightings are larger contributors to excess return than duration and term structure management.
TIM’s team-oriented approach emphasizes in-house research and seeks to limit non-systemic risk. Our entrepreneurial investment culture is based on a combination of ultimate individual accountability in conjunction with aggressive peer scrutiny, which results in transparency throughout the entire process.
TIM believes that it is essential to gauge the outlook for the economy, Federal Reserve policy, interest rates and the investment environment when managing fixed income portfolios through the economic cycle. This focus assists us in the management of sector allocation, duration and portfolio term structure. Other factors considered in this analysis include the political environment and its potential impact on fiscal policy, taxes, regulation, foreign trade, consumer confidence, entrepreneurial risk-taking, and the outlook for corporate growth.
We also assess the demographic changes which can influence demand for products and services and the outlook for growth in our major trading partners, in order to capitalize on longer term, secular changes in the economy. The entire team also reviews events occurring in each of our analyst’s respective sectors. We then synthesize our top-down and bottom-up conclusions into an outlook for specific sectors within the economy and for the economy as a whole. This process culminates in a quarterly investment outlook publication summarizing Transamerica’s view on the economy and current investment opportunities.
The portfolio team will generally take a moderate duration position against their benchmark (the Lehman Aggregate or Lehman Gov’t/Credit benchmark) in accordance with their view on the economy. The objective is to primarily add value via individual security selection and to use maturity/duration positioning as a secondary source of return. Changes in the duration of the portfolio are typically not altered on a frequent basis, but rather only when the investment team determines such a change to be consistent with significant changes within the macro-economic environment, including inflation expectations. Historically, changes in portfolio duration positioning occur 1-2 times per year, with duration positioning constrained to +/-10% of the benchmark.
Yield curve analysis and management is another source of added value in TIM fixed income portfolio management. Our economic and Fed policy outlook results in a yield curve strategy to capitalize on anticipated changes in the shape of the yield curve.
We believe that active sector allocation (between US Government, corporate, mortgage-backed, asset-backed and convertible bonds) is an important source of excess returns. Sector allocation decisions are driven primarily by cyclical factors, such as our economic and interest rate outlook, secular factors, such as demographic change, and technical factors, such as supply and institutional demand, which is calibrated against valuations in each sector. Reviewing historical yield spreads and comparing them to our outlook for a given sector assists us in determining the relative attractiveness of a given sector. Our mortgage-backed securities strategy is determined by our outlook for the yield curve, interest rate volatility, and our interpretation of secular trends in the mortgage-backed market.
Each analyst is required to recommend a weighting (i.e. underweight or overweight) on the sectors they cover in accordance with their outlook for relative fundamental performance. Inputs assessed in making this determination include the economic outlook, input costs, pricing power, capacity utilization, global competition, as well as near term financing needs. Our outlook for specific industry sectors assists us in the search for improving credits in beneficial environments.
Original and proprietary research is the core of our investment process and has added value across asset classes and through time, for over 20 years.(we already said that). In addition to a dedicated and highly experienced fixed income research team, our portfolio managers (who are analysts as well) also have access to a large group of equity analysts.
TIM seeks high quality companies with superior business models that are undergoing organic growth. This optimizes the prospects for rapid growth in earnings and cash flow, an improvement in credit metrics, ratings upgrades from the rating agencies, and price appreciation. Significant emphasis is placed on the business model and on management, with a clear preference for management with past records of which acting in the best interest of debt-holders.
We believe that we add value when we identify early stage positive changes affecting a company or a sector, which the market has yet to discern. This groundswell of change may be a result of longterm secular trends such as changes in demographics or technological advances, or more fundamental changes occurring within a company, such as a management-related change. Because the type of fundamental change we seek to capitalize on takes time, a by-product of our philosophy is low turnover.
TIM seeks companies which are experiencing a substantial and sustainable increase in discretionary free cash flow. Through financial statement analyses, we look at a company’s cash flow and reconcile it back to its earnings. To the extent that the two have diverged through time, further investigation is merited. Sometimes this is a result of efficient use of capital, but at other times this may be a warning sign that the business model is unsustainable, or at the extreme, there may be financial fraud. We seek companies exhibiting high potential forrevenue and earnings growth, and strengthening balance sheets .
TIM seeks to identify companies exhibiting the highestcredit improvement potential at the most attractive price. The relative valuation process involves a comparison of a specific credit to other credits, calibrated with its prospects for credit improvement. When a corporate bond is purchased, a valuation target and thesis is presented by the analyst, with the target valuation stated either in terms of other credits of lesser risk, or credits in similar industries with higher credit ratings. TIM’s analysts spend most of their time at the trading desk, resulting in a honed sense of relative valution.
TIM’s process for selecting mortgage-backed securities is very similar to its process for credit selection. Like our credit selection process, the process begins with a top-down view which includes a view on the direction of interest rates, interest rate volatility, home prices, and the projected shape of the yield curve. This view drives our strategy in selecting the coupons, maturities and structures that will likely outperform in the given scenario.
As with our credit selection process, the top-down view guides us towards the most appropriate securities to evaluate for purchase. Once the desired coupons, maturities, and structures are selected, we carefully evaluate specified collateral for characteristics deemed desirable to achieve the optimal prepayment characteristics. Such characteristics include the weighted average life, seasoning, geographic dispersion, and average FICO scores of the loans and borrowers in a given pool. Because we seek to optimize these characteristics, we do not generally participate in the roll market, choosing instead to pay-up modestly for the most desirable characteristics. We use internally generated models to assess the likely period
Like with our credit selection process, its by-product is low portfolio turnover, and maximized quality and liquidity.
All TIM bond portfolios are well-diversified with respect to issues and sectors, and will generally consist of 40 to 70 securities (with corporate issuers representing less than 3.0% and mortgage backed pools representing less than 5.0% of the portfolio, respectivel). Industry weightings are limited to 15% of the portfolio as defined by Lehman’s industry sub-sector breakdown. TIM’s Core (Aggregate) Fixed Income portfolio is managed with the objective of being fully invested, with cash levels typically well below 5%. Derivative securities are not used in the management of this product.
CMS BondEdge is used to measure duration, convexity and yield by sector and to insure that portfolios remain within any predetermined parameters for credit quality and industry concentration. Proprietary models monitoring credit exposure by portfolio provide another level of analysis. Because we believe that there is no substitute for fundamental research, computer and optimization models are not used in the construction of portfolios.
Finally, a dedicated compliance department reviews overall processes on an ongoing basis, and monitors all portfolios. Client restrictions and guidelines are documented and quantified on TIM’s portfolio accounting system. Compliance with client guidelines is reviewed on a regular on-going basis by the portfolio manager and the compliance staff.
Our sell discipline includes several factors, including: the realization of the original investment thesis, a debt maturity, a better idea, and overvaluation relative to other like securities, a deterioration in company fundamentals, or a change in the original investment thesis.
For mortgage-backed securities, a sell is initiated if the specified collateral has exhibited poor prepayment characteristics for more than three months in a row, or if there has been a change in our outlook for interest rates, interest rate volatility, or the technical environment supporting mortgage-backed securities. Such factors may include changes in banking sector demand for alternative assets such as commercial and industrial loans, or changes in the mix of demand between adjustable rate mortgages and fixed rate mortgages.
Portfolio Managers and analysts sit on the trading desk and generally trade for the portfolio they manage. TIM’s dedicated trading group has developed an extensive network of brokers, and is able to leverage negotiations for best execution practices, due to our organization’s size.
Our internal credit research is presented at our daily and monthly research meetings. Monday meetings tend to focus on a review of the ongoing economic outlook, investment strategy, and positioning, while Monthly meetings tend to cover more comprehensive reports such as buy or sell recommendations. TIM’s entire investment team convenes daily by conference call to go over economic indicators, news impacting our holdings, and new investment ideas. This daily call culminates in a trade review of all trades which took place in the institutional portfolios, a process which ensures full transparency on an ongoing basis. TIM’s extensive peer review process also incorporates daily internal meetings/conference calls involving the Chief Investment Officer, portfolio managers and analysts of all investment classes.