In the bond market, it can pay to be smaller, says Tad Rivelle, chief investment officer of Metropolitan West Asset Management.
The Los Angeles money manager, with ocean-view offices on Wilshire Boulevard, manages US$13 billion of bonds, mostly for institutional investors. That compares to US$220 billion at market leader Pacific Investment Management Co, in nearby Newport Beach, where Rivelle and three of his six co-founders started out in the early 1990s.
Metropolitan West runs two no-load bond mutual funds whose performance testifies that smaller can be better. Metropolitan West Total Return Bond Fund has the second-best three-year record among intermediate-term investment-grade funds, the most popular kind of bond fund according to fund tracking firm Lipper. A sister fund that takes less risk, Metropolitan West Low Duration Bond Fund, has the best three-year record in its class.
The key to beating the averages in the bond market is identifying bargains -- bonds that, for one reason or another, are cheaper than they should be, Rivelle said. If you're small, you can scoop up a bargain without causing it to disappear.
"Because we're not a US$50 billion behemoth we're able to enter and exit without moving the market," Rivelle said. "We can exploit these inefficiencies without repairing them." Metropolitan West runs just three mutual funds, the two bond funds and Metropolitan West AlphaTrak 500 Fund. AlphaTrak 500 combines bonds and Standard & Poor's 500 Index futures in an effort to outperform the benchmark equity index, which it has done since its 1998 inception.
But bonds are king at the firm, which does no other equity-related investing.
Rivelle, 40, was co-head of fixed income at Hotchkis & Wiley in 1996 when the Los Angeles firm's partners started negotiating to sell it to Merrill Lynch & Co Five of the six co-founders of Metropolitan West were part of his team. Jealous of their independence, they moved to set up their own shop before the Merrill transaction closed.
The bond funds -- which buy all types of investment grade bonds, from US Treasury and federal agency issues to corporate bonds and mortgage and asset-backed securities, and a few junk bonds -- may have been started only four years ago, but the managers have been working together far longer. "Our approach to management has been somewhat time-tested," Rivelle said.
The managers have five ways of looking for value in the bond market, Rivelle said. One involves comparing the current level of rates to historical levels. Another is tracking the difference between short-term and long-term rates. In using them, the managers defer to what Rivelle calls the bond market's "historical heuristics" -- its tendency to revert from extremes to averages. "We eschew in-the-moment thinking," he said.
A third strategy, which Rivelle said large firms may find difficult to employ because of their tendency to move the market, is determining which sectors to favor and which to avoid. It's a question of whether yields on corporate, mortgage and asset-backed bonds are high enough relative to Treasury and federal agency bonds to compensate for the risk of an economic slowdown.
Regardless of which sectors the funds are favoring, they tend to have larger holdings of asset-backed securities than the market as a whole, Rivelle said. That's because asset-backed securities -- which turn consumer debt like home-equity loans and credit card receivables into bonds -- suffer from neglect, and so tend to be cheap, he said.
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