Investment Strategy
At AUIM, portfolios are managed under a uniform investment approach which is driven by a seasoned group of investment and risk management professionals performing in a team oriented environment focusing on fundamentals, technicals and valuation throughout each step of the process.
AUIM strives to exploit the inherent inefficiencies of the market and outperform the BofA Merrill Lynch 1-3 Year U.S. Corporate & Government Index over a full market cycle while achieving a high level of current income with minimal fluctuation in principal value and liquidity.
Unlike a core bond fund, the Short Duration product seeks a lower level of price volatility due to its lower duration (interest rate sensitivity) than that of a typical core bond fund. Unlike a money market fund, the Short Duration Bond product seeks a higher level of current income and a higher yield, yet this product exhibits more price volatility as the product does not seek to maintain a stable $1 NAV.
Screening Process
AUIM’s Short Duration strategy uses fundamental research to capitalize on misvaluations in the least efficient portions of the fixed income markets. The research process seeks high quality bonds whose potential for growth is not reflected in current valuations. A portfolio holding such bonds offers the prospect of higher returns from both capital appreciation and higher income. Security selection and sector allocation therefore constitute the primary source of excess returns, with duration and term structure positioning a secondary source of additive return. This produces a well-diversified, higher quality return than many of our competitors who rely more heavily on duration positioning to generate excess returns. A by-product of our process is a lower-than-average turnover.
Security selection, sector allocation, duration and term structure positioning all begin with a “top-down” analysis of the economic environment. AUIM’s economic outlook is developed through a combination of ongoing analysis of daily economic indicators, secular trends, and analyses of the economy’s component parts from our sector analysts. Factors considered in this analysis include economic growth, central bank policy, inflation, the political environment, taxes, regulation, consumer confidence, demographic changes, and the outlook for corporate growth.
Duration Management
We will generally take a moderate duration position against the benchmark in accordance with our view on the economy and interest rates. 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. Historically, significant changes in portfolio duration positioning occur 1-2 times per year, with the average portfolio duration positioning constrained to a maximum of 2.5 years and a minimum of 1 year.
Sector Weightings
We believe that active sector allocation (between US Government, corporate, mortgage-backed, asset-backed and commercial mortgage backed 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.
Industry Weightings
Each analyst recommends 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.
Credit & Structured Product Research
Bottom-up credit analysis is applied to all credits where analysts evaluate the business model and financial statements with particular focus on cash flow generation, debt levels and liquidity, management track records, current events and projected future credit statistics. An overlay of top-down economic, business cycle and sector trend analysis is applied to investment candidates; this step will impact the reluctance to take credit risk in certain industry or rating categories.
In structured products, MBS and ABS, we focus on securities with superior and predictable collateral and transparent and robust structures. Further, we conduct proprietary and intensive modeling and stress testing for principal protection and performance. Additionally, loan underwriter, servicer, and issuer track records are closely scrutinized.
Superior Business Models
We seek to invest in a portfolio of companies that offer distinct and sustainable competitive advantages. Many of these companies maintain dominant market shares and have significant barriers to entry, exhibit product or cost structure advantages, and maintain operational transparency. We also prefer to invest in companies that demonstrate organic growth (instead of growth through acquisitions), and recurring revenue models which can bring unit volume increases to the bottom line. Because it takes time for unrecognized positive change to impact credit ratios and to become fully recognized, a by-product of our process is very low turnover.
Proven Company Management
Our goal is to invest in companies that have management teams that are experienced, prudent, and visionary, have a history of success and act in the long-term best interest of debt-holders, particularly through the effective balancing of shareholder and debt-holder interests. Frequently we find that a manager’s past history of success and failure is a good predictor of future success or failure.
Portfolio Construction Methodology
AUIM’s Short Duration strategy is focused on fundamentals, technicals and valuation at each step of the investment process for owned and considered credits. The process begins with idea generation and preliminary screening, followed by decision making based on credit analysis and evaluation and finally the continuous management and monitoring of the portfolio. In constructing each portfolio AUIM’s goal is to maximize total return over a full market cycle time horizon.
Buy/Sell Discipline
Critical to the investment process is the identification of companies exhibiting the highest credit improvement potential at the most attractive price. We want to make sure that we don't overpay relative to a company's intrinsic risk or relative to alternative investments within an industry. The relative valuation process involves a comparison of a specific credit to other credits with similar levels of risk, or of similar industries and ratings, calibrated with its prospects for credit improvement. When a security is purchased, a valuation target and thesis for improvement 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.
Our sell discipline includes several factors, including: the realization of the original investment thesis, identification of a better idea, overvaluation relative to other like securities, a deterioration in fundamentals, a change in management strategy, or a change in the regulatory environment. However, due to the near-term maturity of the majority of the portfolio, individual securities are often held until they mature.
Trading Execution Strategy
AUIM Short Duration trades are executed by Portfolio Managers as we believe this improves overall performance by keeping Portfolio Managers in constant communication with Wall Street trading desks and in the center of information flow. Particularly important in the Short Duration asset class is the Portfolio Manager’s knowledge of market technicals, which allows for the Portfolio Manager to be abreast of these technicals, thus assuring the best execution possible for each trade. Short Duration Portfolio Managers receive quotes from Wall Street firms, and then establish the best plan of execution based on price and ability to execute trade in the necessary size with the smallest market impact.
Additional Comments:
AUIM has a strong culture of risk management within their investment framework. They recognize the asymmetrical nature of fixed income and have expertise in managing portfolios with numerous constraints. The heart of this risk management culture within the Short Duration portfolios is AUIM's rigorous credit review process. This includes the close interaction and involvement in credit underwriting between their portfolio managers and research analysts.