I believe successfully managing an investment-grade bond strategy begins with answering the big macro questions correctly. That was never truer than at the depths of the Global Financial Crisis, when I joined OppenheimerFunds in March 2009 as Head of the Investment Grade Debt Team, and took the reins of Oppenheimer Total Return Bond Fund.
Out of Crisis Came Unprecedented Opportunity
Out of the crisis, a new monetary regime was emerging. The U.S. Federal Reserve (Fed) was lowering the Fed Funds Rate toward zero and forming a series of special lending facilities, designed specifically to recapitalize the U.S. banking system and to reflate U.S. financial assets. The optimal word being reflate. There wasn’t too much more that investors needed to know.
The Fed’s massive policy response focused on removing the risk that the U.S. economy would enter a much-feared deflationary quagmire. On the other hand, concerns that the Fed’s actions would result in massive inflation were overstated, if not hyperbolic, given the deleveraging required in the private sector. It was to be a slow growth, benign inflation environment indefinitely, resulting in suppressed interest rates and outsized risk-asset returns. Portfolios needed to be adjusted accordingly. If the age-old adage guides us to not fight the Fed, then this time it would apply in spades.
The Need for a Persistent, Vigilant Focus on Risk
In building OppenheimerFunds’ Investment Grade Debt Team, I instilled a risk-controlled framework designed to enable the team of experienced investors to take advantage of the many attractive opportunities that were presenting themselves, but in a way that was truly aligned with the objectives of the portfolios. For example, investment-grade bond strategies, even in elongated bull markets, are designed to generate steady income and provide diversification from equities – that is, to serve as ballasts or stabilizers in a portfolio, rather than an additional source of risk when equity markets decline. Making a big bet on credit or being considerably long duration, while perhaps directionally aligned with our views, would have produced a risk-return profile that, at select points in the cycle, would have been misaligned with investors’ expectations.
Instead, the Investment Grade Debt Team is charged with offering income and total return as well as portfolio stability. In this pursuit, the team constructs portfolios to source yields and generate returns across an array of securities within different income sectors. The long-term drivers of performance are not intended to be attributed to any one exposure or position. For example, the strong relative returns of Oppenheimer Total Return Bond Fund over the past 10 years have been roughly equally attributed to the team’s asset allocation to sectors such as U.S. corporates, mortgage-backed securities, and asset-backed securities, as well as to its security selection within those sectors. That is by design and we are heartened by the results.
The same risk-controlled framework is one that I have now led for years in my position as Chief Investment Officer, across OppenheimerFunds. Within their respective markets, our investment teams are incentivized to allocate their risk budgets where they believe they are being adequately compensated. The direction for the investment teams is always to align with the objectives of the investors, to control the risks they take, and to eliminate any unintended or unwarranted bets in their portfolios. It is a framework that has served our investors well, and I believe it will continue to do so.
It’s hard to imagine that it has been 10 years since the immediate aftermath of the financial crisis. While much has changed, the overarching macro environment has generally stayed the same. The biggest differences between now and then are that valuations are no longer as attractive as they once were, and corporate debt has been growing for a decade. Both warrant watching but currently neither is an immediate cause of concern. U.S. credit spreads can trade tight to U.S. Treasuries for a prolonged time until a monetary policy mistake or a severe disruption in economic activity emerges. And while credit growth has been strong, corporate fundamentals remain sound.
The reality is that we still live in a growth-starved world, with inflation still largely absent and monetary policy still fairly accommodative in most of the world. I recently released a paper titled “Five More Years” where I provide a series of evidence to suggest that the end of this cycle is not only not imminent, but unlikely to occur within the next five years. To say that this current business and market cycle could go on for much of the rest of my career (I don’t intend on retiring soon) might not be an overstatement.
We can be proud of the Investment Grade Debt Team’s outperformance over the past decade, but specifically the fact that it has been achieved with reasonable risk relative to the broader market. Our commitment to risk management in providing a superior investment experience remains paramount at OppenheimerFunds, and I am confident that this is what will enable our clients’ success over time – regardless of how long the cycle extends.