Western Asset Core Bond Fund (WATFX), is a bond fund that outperforms in both up and down markets, observes Todd Rosenbluth, mutual fund expert and analyst with CFRA Research.
The CFRA Focus Mutual Fund for November is Western Asset Core Bond Fund. In rating taxable bond mutual funds, CFRA combines holdings-level analysis with fund attributes, including the relative track record, costs and exposure to credit and interest rate risk.
WATFX has outperformed its Core bond fund peers on a one-, three-, five- and ten-year total return basis, with outperformance in the last four full calendar years. Year-to-date through October 26, the fund’s 2.09% loss was 11 basis points behind the peer average.
The fund’s track record includes outperformance when the average bond fund lost ground (in 2013 and 2015), as well as in years when bond funds generated positive returns (2014, 2016 and 2017). We find it rare for funds to succeed in both up and down markets.
On a risk-adjusted basis, the fund’s three-year standard deviation of 2.8 was modestly above the peer average’s 2.6, yet the fund’s Sharpe ratio of 0.57 was more than double the average. The fund’s below-average 0.46% net expense ratio and turnover rate of 102% were well below the peer average of 0.72% and 192%, respectively.
Such favorable performance and cost factors provide a boost to CFRA’s rating. At the portfolio level, the fund’s 3.2% 30-day SEC yield is higher than the 2.8% for its peers. With bond funds, investors should expect to incur additional credit or duration risk when offered an above-average yield.
CFRA’s approach helps to identify how this occurs and puts these risks in perspective. For WATFX, the risk stems from its modestly elevated average duration of 6.5 years (5.7 years for its peer group).
One of WATFX’s portfolio managers, Mark Lindbloom, explained to CFRA in an early October interview that management expected slow economic growth to persist limiting the rise in interest rates. Meanwhile, the fund earns a low risk considerations input for the credit quality of the portfolio.
Approximately two-thirds of assets are rated AAA or AA (or equivalent), according to our research, and the fund has negligible exposure to high-yield bonds. Some of WATFX’s peers have outperformed by taking on credit risk through hefty stakes in low investment grade bonds.
However, Lindbloom and his team run a more conservative portfolio. In the third quarter, Lindbloom explained, the fund made some adjustments to the its positioning to reduce its risk exposure. This included a reduction in bank loans and collateralized mortgage backed securities (CMBS).
Meanwhile, management added short-term Treasuries. At the end of September, 49% of the assets were invested in mortgage-backed securities (MBS), with a 24% weighting in investment-grade corporate bonds. Most of the MBS was split between Fannie Mae and Ginnie Mae bonds, while corporate bonds include financial issuers such as Bank of America and Goldman Sachs.
In addition, Lindbloom highlighted the fund’s primarily dollar-denominated emerging market bond exposure (8% of assets) as an example of how management wants to ensure it is being compensated for risk. Western Asset management combines a value-oriented fundamental investment approach with a top-down macroeconomic view to run this and other bond strategies.
While this is the institutional share class of the portfolio, an A share class with a lower minimum initial investment, but a higher 0.8% expense ratio, is available under the ticker WABAX.
In addition, Lindbloom and the Western Asset management team are also running a more flexible version of this strategy with Western Asset Total Return ETF (WBND). This new actively managed ETF has a 0.45% net expense ratio.
