Wond market, ING Investment Management is positioning itself for better returns abroad.
“Global diversification is an attractive opportunity,” said Christine Hurtsellers, CFA, chief investment officer of fixed income and proprietary investments for ING. “There’s ample opportunity over the coming years within both developed foreign-bond markets and emerging markets.”
Simple math underpins ING’s investment thesis. Yield on the benchmark 10-year U.S. Treasury note has fallen to about 2% as of April 2012 from 5% five years ago. The compression generated total return of 48% for the years 2007-2011 inclusive, a remarkable run for what is perceived as a risk-free asset.
But with bond yields at record lows, few market participants see much in the way of additional upside. For their part, ING managers expect a generally stable ‘coupon-clipping’ market for at least the near term; not bad, but not good enough to stand pat on domestic positions.
“In this low-interest-rate environment in the U.S., people are continuing to look for opportunities to diversify away from U.S. interest-rate risk,” said Matt Toms, CFA, head of U.S. public fixed income at ING. “Add in the longer-term belief that the dollar is poised to weaken given current fiscal and monetary policy, and that opens up opportunities for foreign currencies and foreign bonds to potentially outperform over a long-term horizon.”
ING Investment Management, based in New York, is the primary asset-management unit of Dutch financial-service giant ING Group. ING Investment Management manages about $166 billion, of which $120 billion is in fixed income and managed out of Atlanta.
Of the fixed-income assets, about $38 billion is in investment-grade corporate bonds; $15 billion is in residential mortgages, predominantly agencies with some non-agency and subprime; and $2 billion is in high-yield bonds. The rest is spread across cash, Treasuries, hard- and local-currency sovereign debt, structured credit, private placement, and commercial loans. Most of ING’s clients are institutional, though there is a $12 billion mutual-fund business.
Balanced Approach
ING seeks to balance its investment approach between top-down and bottom-up, Hurtsellers and Toms told Markets Media in an April 3 phone interview.
“We spend a lot of time analyzing key global macro data — industrial production, central bank activity, etc.,” Hurtsellers said. “We spend a lot of time thinking about where we are in terms of the business cycle itself and valuations, and how that affects different sectors.”
One notable development in recent years amid increasingly interconnected markets is that seemingly local events can affect asset prices globally, said Hurtsellers, who headed ING’s structured-finance group from 2005 to 2008 before ascending to her current role in early 2009. ING’s fixed-income team is well set-up to handle the market dynamic, she said.
“Our different asset teams are critical in informing the feedback loop about the opportunities in various markets and what has been priced in,” Hurtsellers said. “Our investment team is very flat and very interactive in terms of people having their say in investment decisions and dialogue.”
In Hurtsellers’ view, lingering economic weakness is enough for the U.S. Federal Reserve to keep interest rates very low “for a while.” That implies a yield ceiling of about 3% for 10-year Treasuries and 0.5% for two-year Treasuries.
“That said, it’s a fool’s game to predict interest rates, and the market is emotional,” Hurtsellers said. “In the fall, everyone thought the world was going to end. Now, people are saying GDP could be north of 3% this year, so everything is great. But everything isn’t great.”
Specifically, Hurtsellers’ concerns about developed-market political risk were brought to light in the third quarter of 2011, when a rancorous legislative debate regarding the U.S. Treasury debt ceiling touched off a market swoon and resulted in only a stop-gap fix. The upcoming presidential election has the potential to reignite the debate.
“We had a very bad experience with the Treasury debt-ceiling debate last summer,” Hurtsellers said. “And if you start to look at the math — in terms of payroll tax cuts, the Bush tax cuts, etc. — there’s a real fiscal headwind facing the U.S. and our GDP growth. We’re kind of at an inflection point, as I don’t know if we can get any more meaningful improvement in unemployment without some pretty nice nominal GDP growth.”
Political risk can be especially vexing for investment managers because of the sometimes-capricious decisions of government leaders. For instance, Hurtsellers worries that a sudden resolve to tackle the U.S. deficit could result in too-quick action and cut off the economic recovery.
Amid the qualms about the market’s direction, “we’ve started taking some risk off the table and have been managing duration carefully,” Hurtsellers said. “But we’re still looking for opportunities.”
Within fixed income, Toms said the emerging-market and high-yield sectors hold appeal, while Treasuries, Treasury Inflation-Protected Securities (TIPS) and short-dated corporate bonds have run up considerably and are less promising.
ING’s Core Plus Fixed Income’s investment mandate allows for as much as 20% in emerging-market and high-yield debt, combined. As of December 31, 2011, Core Plus Fixed Income held 46% AAA-rated securities, compared with 75% for the benchmark Barclays Capital U.S. Aggregate Bond Index. Bonds rated below BBB, considered high yield, and unrated bonds comprised 15.2% of ING Core Plus; the BarCap benchmark had nothing below BBB.
Emerging Appeal
Toms expects more emerging-market companies to issue bonds in coming years, diversifying income sources for investors. By way of geography, ING favors countries that have already been through a full monetary-tightening cycle, such as Australia. That investment selection “provides bond investors the opportunity to benefit from declining interest rates should global growth remain soft,” Toms said.
ING prefers Latin America over Asia and Europe, as nations such as Brazil and Mexico offer attractive growth prospects and yields, Toms said. No matter where on the globe bonds are found, “it’s important that the client understands the extra volatility that is infused in emerging-market investments,” he said.
Absolute yields of about 7% on U.S. high-yield bonds are lackluster, but the spread of about 500 to 600 basis points above Treasuries makes the asset class a worthy investment, according to Toms.
“The risk premium is still quite substantial on a historical basis, and it could easily compress another 100 basis points before you run into significant headwinds,” Toms said. “In a world of low yields, we think investors ultimately will continue to seek out investments that offer something extra, and the high-yield asset class will be well supported.”
Additionally, ING maintains a direct-lending commercial real estate team. “It’s one of our key strengths and a place where we can generate real insight,” Hurtsellers said. “We build proprietary commercial real estate loss models that are leveraged to help evaluate Commercial Mortgage-Backed Securities in our public funds.”
The market for the most attractive commercial properties has rebounded, but in Hurtsellers’ view, there are opportunities under the radar. “People have really shied away from what we would call secondary or tertiary markets due to worries about regional banks (and) commercial real estate portfolios,” she said. “Valuations for the given level of risk are really quite compelling for some of these ‘less fancy’ markets, if you will.”
A slowly improving job market should buoy commercial real estate valuations. Even without that expected boost, commercial real estate may fare comparatively well in the event of a negative market event such as a significant corporate bankruptcy or an inflation scare, as “people often will opt to buy hard assets as inflation hedges and because they tend to hold their value.”
ING’s $120 billion in fixed-income assets under management has increased by $10 billion since 2010. The business is in a size 'sweet spot', according to Toms: assets under management are sufficient to support robust manpower — 100 employees — and infrastructure, yet it’s not of a size that orders will move markets.
“One of the levers we use is asset allocation — adjusting sector allocations to drive value,” Toms said. “Some of our peers are probably too large to do that nimbly...somewhere in that $400 billion to $500 billion range you get to a point where you have to get more macro, because your bottom-up ability to source bonds could become difficult.”
“If you’re too small you may not have a deep enough team to focus on each individual asset class or have robust research teams,” Toms continued. “But if you’re too big, you may not be able to buy a corporate bond because there may be only $250 million in existence and you need to buy $200 million.”
Stalwart Products
According to institutional-investment data provider eVestment Alliance, ING’s biggest institutional bond product is Stable Value, which had about $12 billion as of the fourth quarter of 2011.
Aiming to provide returns similar to intermediate-term bonds, but with lower risk, Stable Value “is not the most exciting investment but it provides clients access to yield that’s better than some alternatives,” Toms said. “This is an area in which there have been substantial inflows over the last three to five years, since the economic downturn.”
Senior Loan was ING’s next-biggest institutional fixed-income product at $9.5 billion, followed by Core Plus Fixed Income at $7.6 billion and Core Short Duration at $3.6 billion.
The Core Intermediate segment of the Stable Value product returned 7.17% annualized over the three years ended 2011, beating its benchmark by almost a full percentage point and ranking in the top 2% among comparable institutional offerings, according to eVestment Alliance. The five-year annualized return, which includes 2008, slips to 5.63%, less than the benchmark’s 6.09%; it still ranked in the top 13% versus competitors.
ING’s Senior Loan product returned 19.7% annualized for three years, in the top 20% of comparable institutional products, and 4.56% over five years, in the top 44%. Core Plus Fixed Income’s performance ranked at about the median over three years, but slipped into the bottom quintile over five years including 2008; returns improved to rank almost in the top quartile in 2011.
ING’s core fixed-income products “struggled” in 2008, when the collapse of Lehman Brothers and other events touched off a late-year cratering in the asset prices of most risky asset classes, according to Eric Przybylinski, senior research analyst at institutional-investment consultant Marquette Associates.
Hurtsellers took over the group in February 2009, and introduced improvements such as using a more consistent application of global-macro and business-cycle analysis across fixed income. “Their recent numbers have rebounded somewhat,” Przybylinski told Markets Media. “Their loan offering is solid, and they have a strong global bond product.”
ING’s offerings lean toward more suitable for bond investors with a higher risk tolerance, Przybylinski suggested. “For example, ING's global product is multi-sector and benchmarked against the BarCap Global Agg,” he said. “Their performance compared to that benchmark has been strong but they have at times taken large relative exposures to high yield and emerging markets, which is something prospective investors should be aware of.”
ING’s core and core-plus products have comparatively high allocations to non-agency securitized products that can potentially generate excess return. With regard to systems and infrastructure, Przybylinski noted that ING has worked to build out its quantitative and risk-management capabilities over the past several years.
Trading Approach
Bond trading can be more challenging now compared with five years ago when liquidity was essentially free, according to Hurtsellers, who plans to run this year’s Chicago and New York marathons.
“In dealing with a world of higher-cost liquidity, we spend quite a bit of time analyzing forward-looking asset allocation changes and trades, so we’ve had to incorporate higher bid-asks in that dialogue,” she said. “It’s a lot harder to navigate out of things ahead of the market.”
Specifically, ING is steering clear of CCC-rated debt, the lowest non-defaulted grade in high yield. Companies with that rating will find it hard to survive amid weak economic growth, and their bonds have become more illiquid, Hurtsellers said.
ING grooms its traders to be experts in their specific areas rather than generalists. “We are not believers in the collective trading desk model, where there’s a trader that will trade currencies, or securitize credit, or investigate a high-yield credit as a centralized function,” Toms said. “We think you can keep costs lower by putting that trade in an OTC market in the hands of a sector specialist.”
Given the interconnectedness of fixed-income markets, ING’s sector specialists are not siloed; rather, regular cross-pollination is encouraged. Investment-grade traders, for instance, need to know what is happening in the subprime debt market, because investment-grade banks that hold subprime debt will be affected by moves in those securities.
“You want different teams to talk as much as possible,” Toms said. “It’s key to keep the lines of communication across the desks as open as possible, so that unique insights can be shared.”
In Toms’ view, ‘mega’-sized corporate-bond deals can be traded electronically, but beyond that he is not bullish on the prospect for expanding electronic trading much beyond Treasuries, currencies and some agency securities.
“This is a lot like fiscal reform — it’s talked about an awful lot, but it isn’t practiced a whole lot,” Toms said. “Some of that is because the motivation to change is not very strong for the vested interests within the fixed-income markets, both from the buy side and the sell side.”
“The sell side has a lot of high-quality people, careers and franchises that are built upon trading fixed-income markets in the way that’s existed for many years,” Toms continued. “On the buy side, while people want to have more transparency and lower trading costs, those firms that have built strong relationships with the sell side also have a preferred position at the table, if you will, as far as being able to navigate the fixed-income trading markets.”
Little has changed with regard to how credit-default swaps and other derivatives trade, even with a regulatory push and massive media attention since 2007, Toms noted.
It makes sense for bonds of $1 billion and above issued by household names such as Goldman Sachs, General Electric, and JPMorgan Chase to trade electronically, Toms noted. More clarity and transparency in the pricing of such benchmark bonds should lead to “less inefficient” OTC markets in smaller issues of the same issuer, as well as big issues of comparable issuers.
Toms, an avid golfer who joined ING from Calamos Investments, contrasted the largest and most liquid corporate bonds with a $250 million, 30-year utility issue that might trade once every two years.
“Nobody is going to make a living actively quoting or trying to trade that bond,” Toms said. “It’s the same with a lot of segments of the structured securitized market, be it CMBS, non-agency mortgage, or mortgage derivatives. These are small instruments that probably need the care, time and attention of an OTC market.”
Managing Risk
Risk management has become more of a focal point for investors in the wake of the financial crisis of 2008-2009, which disproved the notion that diversification alone is sufficient to avert big losses. Risk management now has its own 45-minute presentation as part of the due-diligence process, Toms said, where it used to be 10 minutes at the end of a meeting. Client questions are mostly about liquidity and counter-party risk.
ING deploys BlackRock’s system for risk and portfolio management, and it maintains an independent risk-management group that does not report to Hurtsellers. “This structure we’ve implemented in the last few years has resulted in a great partnership but assures that the chief risk taker and the chief risk officer are not one and the same,” she said.
“You absolutely have to be risk-aware and manage your risk budget actively for your clients given their individual mandates,” Hurtsellers said. “Having the portfolio managers, the analysts, the risk management team, and our corporate audit services staff all seeing the same data, using the same suite of tools, and all on the same page regarding what we’re trying to accomplish, assures that everyone is working towards the same goals.”
Portfolio risk and regulatory risk are among risks for which ING is on heightened alert. One manifestation of evolving portfolio risk is that interest rates are no longer as correlated with yield spreads as they used to be, given the increased importance of quantitative easing in the market over the past few years. Regulatory risk entails new rules taking shape around the world, and the implications for banking, insurance, pension and other sectors.
Aside from its global investment capacity and being in the range of optimal size of assets under management, Hurtsellers said a key differentiator for ING is its active management style.
“In this world of very high volatility, we feel you can pick one of two kinds of managers,” she said. “You can pick a manager who is long credit all the time regardless of the cycle. Or you can pick a manager who is both opportunity- and risk-aware, one who will manage your portfolio based on where we are in the cycle.”
Added Hurtsellers, “given global imbalances, monetary intervention and changing relationships, having the manager who is prepared to navigate through the changing market dynamics is a critical competitive advantage.”
