This go-anywhere fixed income fund's risks have been well rewarded

Manulife Strategic Income can serve as a complement to core bond funds in a diversified portfolio.

Jeffrey Bunce, CFA 13 March, 2018 | 5:00PM
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The objective of Manulife Strategic Income is to earn competitive returns while keeping volatility under control. The manager aims for a relatively high Sharpe ratio -- a measure of risk-adjusted performance – and have delivered on that promise over the fund's history, which dates back to November 2005, making this fund a strong fixed income candidate for inclusion in an investor's portfolio.

Investors should be mindful that the fund possesses more corporate credit exposure and a correlation with equities a notch above traditional core bond funds, though, meaning it may better serve as a complement to core bonds within a balanced portfolio.

The key to this fund's successful record has been a well-executed strategy of combining sector rotation with currency management and credit selection. Interest rate management also factors into the mix. The fund will take meaningful stakes in whatever segment of the fixed income market its management team deems most attractive, whether it is U.S. high-yield, foreign government bonds (including emerging markets), investment-grade credit, U.S. Treasuries or securitized paper. The fund can go down the capital structure and own convertible bonds, preferred shares and even common stocks in small amounts.

Allocation, currency and rates decisions are based on systematized research, which scores each country across the globe in terms of rates, currency, credit and liquidity. Monetary policy, rates differentials, valuations, political considerations and global "risk-on/risk-off" sentiment all factor into these scores. The final portfolio reflects these global views.

The asset-allocation calls are based on global macro considerations and valuations, and the prime decision-makers for these moves are lead manager Daniel Janis and co-manager Kisoo Park. The duo also takes the lead on the fund's active currency management -- the fund can and does make outright currency bets even apart from hedging (Janis used to be a currency trader at one of his previous jobs). The third comanager, Thomas Goggins, focuses on credit research. Over the years since the fund launched, lead manager Janis has diligently built out his supporting cast to the point where his global multi-sector team now totals 11 people. He also taps into Manulife's 20-member credit and securitized team and 58-member Asia team, among others, for ideas.

Typical of many go-anywhere bond funds, this one doesn't have a natural benchmark; comparisons with the Bloomberg Barclays Multiverse index are meant more for illustrative purposes. The fund has few restrictions: Its volatility target is in the 4% to 8% range, it can move duration between two and six years, and can invest in all credit tiers (including common stock). The fund has used these freedoms; in post-crisis 2010, for example, it held almost 40% in U.S. high-yield bonds while this number is around 18% as of December 2017.

The fund's recent positioning has been leaning conservative, at least relative to its history. Janis and team decided to reduce the portfolio's risk as far back as 2014, based on high valuations in credit and other riskier assets. Back then, they rotated out of cyclical industries such as energy and mining toward more-defensive names in the healthcare and pharma industries. This helped them ride out the downturn in oil prices in late 2014 and 2015 and come out relatively unscathed. They've made similar moves to increase the quality of the portfolio over the past few years.

This is not to say that the fund is tame. As of December 2017, just over 60% of its assets were devoted to credit: 18% in high yield and 30% in investment-grade credit, with the remainder in bank loans, preferred shares and a sliver of stocks. Foreign sovereign bonds were the next biggest position at 18%. The fund is also active on currency, hedging most of the portfolio back to Canadian dollars but typically leaving a portion exposed to U.S. dollars as well as other currencies. Securitized issues, at 10% of assets, included asset-backed securities, commercial mortgages and non-agency residential mortgages. Emerging markets accounted for 12% of the portfolio.

One would not expect a portfolio with these exposures to be at the lower end of its volatility range. Yet, the fund's realized volatility over the past three years ending January 2018 was significantly below that of the Bloomberg Barclays Multiverse Index. One needs to adjust this statistic for the fact that this period has generally been a risk-on period with relatively low volatility. Still, over this time, the manager has done well to keep volatility low while producing returns similar to the index.

Given its underlying holdings and past instances of aggressive positioning, this fund may not always look so conservative. Indeed, the manager's own volatility target range suggests that the fund could be quite a bit racier. However, even during its more aggressive periods, the risk has generally been well compensated by higher returns. All in all, Janis and company demonstrate a successful decision-making record which gives confidence that they will continue to deliver superior risk-adjusted returns.

The fund technically falls into the High Yield Fixed Income category, although it may be better suited to the Global Fixed Income category. At any rate, its commission-based share class has a management-expense ratio of 1.98% (including a 0.5% embedded commission payable to advisors) while its fee-based share class clocks in at 0.97%. The commission-based share class ranks on par with the High Yield Fixed Income category median MER of 1.99% for the commissioned-advisor channel, whereas the fee-based share class looks more favourable versus a channel median of 1.14%.

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Jeffrey Bunce, CFA

Jeffrey Bunce, CFA  Jeffrey Bunce, CFA, is a senior investment analyst for Morningstar’s Investment Management group.

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