This month, Bond Fund Intelligence speaks with Warren Pierson and Sharon deGuzman, both Managing Directors and Senior Portfolio Managers at Milwaukee-based Baird Advisors. Parent company R.W. Baird & Co., which is privately held, was a regional brokerage firm that has grown into a global financial services company. We discuss the firm's Short Term Bond Fund and Ultra-Short Bond Fund, as well a number of topics in the bond fund marketplace. Our Q&A follows. (Note: This "profile" is reprinted from the June issue of BFI. Contact us if you'd like to see the full issue or if you'd like to see our new Bond Fund Portfolio Holdings "beta" product, which ships to subscribers Monday.)
BFI: Tell us about Baird. Pierson: As an employee-owned firm, philosophically, we try to keep it elegantly simple. It's about focus and alignment. We really focus on doing great work for our clients. If we do great work for our clients, the clients are happy, the business does well, the Baird shareholders or the employees do well, so it's really just about aligning our interests with those of the clients.... We found that with that focus, the growth of the business tends to take care of itself.
BFI: How long have you been running bond funds. Brown: Our group came to Baird in early 2000 [but] our first career was at the old Firstar Bank (now US Bank).... I joined this group in 1993, 7 years before we came over to Baird. But Mary Ellen Stanek, our CIO, Charlie Groeschell, and Gary Elfe, director of research emeritus, our founding partners, have worked together for over 30 years. Deguzman: I joined the group in 1994, so a year after Warren. We were at Firstar until 2000, and then moved over to Baird.
BFI: Tell us about your fund offerings? Pierson: It's a consistent process across the risk spectrum.... Starting on the short-end of the yield curve would be our Ultra-Short. We're talking about a half year duration, and then segueing into our Short-Term Bond Fund which goes to a 1- to 3-year benchmark (just shy of a 2-year duration), now the Bloomberg Barclays 1-3 Year Government Credit Index. A little further out, we have our Intermediate product, which is a 1- to 10- year product (about a 4-year duration).... Then, moving to our full market funds, our Aggregate fund, goes to the Aggregate index.... All of these funds ... are investment grade.
Our ultra-short we can do a little bit below investment grade, which is a 1% right now. Our Core Plus Fund, which tracks the Universal Index, also a 1- to 30-year index (5 and 3/4-year duration), can purchase up to 20% below investment grade. Across the risk spectrum, it's a very straightforward approach. Everything is dollar denominated; everything is in the cash market. There are no derivatives, no leverage, no foreign currencies. We joke with our clients and consultants that our bond funds behave like bonds because they're full of bonds.
We think our size is a huge advantage -- $53 billion is a fair amount of money, but as a bond manager that's still not very large. But it allows us to be very agile. The reason we don't use any derivatives or leverage ... is we don't have to. So, as we get into the process, it's very much bottom-up. We focus on risk-control, and really build portfolios bond by bond. We have top-down views on the market, interest rates, and the economy that kind of shape for us the risk environment that we're in. But I'd say those top down views are challenged on a day-by-day basis through the bottom-up security selection and research process.
BFI: Did ultra-low yields drive launches? Pierson: In August of 2004, we launched our Short-Term fund, and it has grown at a pretty good clip. It's up to $4.5 billion.... We launched the Ultra-Short at the end of 2013, not because there was so much opportunity in short-term yields but largely because there wasn't a lot [of yield] in money markets. What we found is by having about a half year duration ... we were able to get a yield close to 1% [with money funds near 0%]. We've now got a good 3-year plus track record, and it’s getting a bit of traction. So, we're seeing pretty good growth in that product.
Deguzman: Hitting that 3-year mark was really helpful.... Most clients, whether corporations, or healthcare organizations or even endowments or foundations, are really looking for [a home for] money that they know they probably won't need in the next 6-12 months. So, they're looking for a nice yield without going out too far on the yield curve. It's been a good addition to the overall product lineup.... The [expense] ratio is 30 bps on Short [Term], and on Ultra-Short ... it will stay at 15 bps at least until April '18.
BFI: What are your big challenges? Pierson: I talked a little bit about supply, and because of our size it's a real advantage.... You look at some of our larger competitors who have AUM of half a trillion or more [and finding supply isn't so] easy to do. So, sourcing bonds isn't a challenge for us. In terms of our philosophy and process, the way that we strive to add consistency ... is by staying duration neutral. We're not trying to add value by guessing on the direction of interest rates.... So, we take a lot of that drama and volatility out of the market by remaining duration neutral, and then focus on adding some incremental relative value relative to benchmark.
The word "incremental" is pretty key. On our short-term fund it would be 15-40 basis points, for full market funds it would be 25-50 basis points. When we do that in a year, we're not the top dog, we're probably in the second quartile. But when you add that incremental return consistently and compound that consistency over the several years, that is when your results go up into the upper echelon into that top quartile or closer to the top decile.
BFI: What sectors are you buying. DeGuzman: If you look at the Short Fund or even Ultra-Short, we're investing in Treasuries primarily for liquidity. We can invest in Government Agencies [though they're] pretty expensive right now. We're investing in the investment grade credit market, industrials, financials, utilities, and then commercial mortgage-backed or asset-backed as well.... [We're] really looking at what's available in the marketplace and what makes the most sense on a risk-adjusted basis. We look at relative value opportunities across the sectors. A lot of times you'll see us looking at a single-A rated finance bond and comparing it to triple-A rated CMBS or ABS.... It depends on what we're being paid to take on those risks.
In the short end [and] ultra-short, we like the asset-backed market and are staying at the top of the capital structure. These securities are triple-A rated, and they are typically backed by consumer receivables, whether that's credit cards or auto receivables. Commercial mortgage-backeds are a little bit harder to find in that short-end space.
BFI: Tell us more about your investors? Pierson: We tend to attract investors, and largely institutional investors, that are looking for that consistency.... On the advisory side, we have a lot of relationships with financial advisors that have more of an asset allocation model with a long-term focus. We don't attract a lot of hot money.... We've got a very stable client base. Advisory firms, (e.g. Schwab or Fidelity), will [use] us more ... with their managed accounts, where we tend to get plugged in as sort of that core holding, whether it's on our Aggregate fund or the Short-Term fund.
What we've seen in our institutional base is investor allocations to core fixed income are probably about as low as they have ever been. That's because the low interest rate environment has endured and people are hungry for yield. So they've gone to other sectors, migrated to things like equities, high yield, bank loans or emerging market debt.... I think because those allocations to core fixed income are lower, investors are very particular that they're going to behave as the expect them to. It gets back to that consistency. I think that what we've found is that we've been growing a lot, taking market share.
BFI: Tell us about your outlook? Pierson: We would expect the Fed to be pushing short term rates a bit higher.... We view this more as a normalization of rates, just trying to get their back away from that zero wall. So, we think in June they will very likely raise 1/4 point. There's a good chance they will do it again sometime this year, but it's going to be data dependent. For the Ultra-Short in particular, while the 10-year Treasury yield is 28 basis points lower year-to-date ... when you look at the 6-month or the 1-year, those yields are up 44 and 32 basis points. So that's actually presented some good opportunity for our Ultra-Short. Our yields have gone up. We would expect over time for there to be on the gradual basis, continued upward pressure on short-term yields.... On the short end of the curve, we think there's probably good opportunities.
