Q & A with Jeffrey Gundlach:
A closer look at Nordea’s US Total Return strategy

What is the main technical difference between the Nordea US Total Return strategy and its competitors?

Our Total Return strategy distinguishes itself along several lines. First, many so-called “active managers” are not actively managing their portfolios. They may differ from the benchmark index, but by adopting fixed overweights and underweights – over the past decade, many have stayed perennially overweight to corporate credit. We actively manage the risks which drive return: credit versus governments and overall portfolio duration. Second, we use no corporates; to achieve our credit exposures, we use private label mortgage-backed securities and other structured credit. Structured credit gives us a yield pick-up over corporates. Third, for our government exposure, we primarily use Agency Mortgage-Backed Securities (MBS), but also some Treasuries. Agency MBS always have lower interest-rate sensitivity and thus lower volatility than corporate bonds and U.S. Treasuries. Utilizing an active management approach to extract these advantages in Agency MBS and structured credit while mitigating the risks within these sectors, we try to construct a portfolio which delivers higher yield with less interest-rate and credit risks versus conventional core bond funds. In other words, the objective is to construct a portfolio which delivers superior risk-adjusted returns.

Why don’t other bond fund managers use this approach, favoring mortgage securities over corporates and Treasuries?

I don’t think they know how. DoubleLine has a large team with market cycles of experience managing across Agency MBS and securitized credit. Other asset managers have teams focused on the same sectors – Agencies, non-Agencies, CLOs, commercial MBS, etc. Buy they don’t know how to integrate the different risk and return profiles of these securities into an efficient portfolio.

Which are the top-3 positions in terms of percentage?

The pools underlying securitizations contain hundreds or even thousands of loans. This is very different from the holdings of a core bond fund with large exposures to the individual balance sheets of big corporations. It’s more helpful to focus on sector and subsector exposures than on a handful of securities. Agency MBS represent about 51% of the portfolio, structured credit 41%, cash and cash equivalents 8%. Within structured credit, the larger holdings by subsector are private label residential mortgage-backed securities at 24%, commercial MBS at 8% and asset-backed securities at 5%.

What is the most important part of managing a fund like yours?

I could fill a book answering that question, but let’s focus on the management of Agency Mortgage-Backed Securities, the largest allocation in the fund. Agency MBS historically have yielded more than Treasuries because investors demand a spread to compensate for prepayment risk: the possibility that refinancing will shorten the average life of securities, thus reducing interest income and returning principal early in a falling rate environment – precisely when an investor would want to stay invested. Agencies also have extension risk: a slowdown in mortgage prepayments, causing bond maturities to extend out. This usually happens when rates are rising – obviously a bad time to be exposed to rising duration.

Over three decades, we have successfully managed through these periods while other MBS portfolio managers have blown up. Their failures often resulted from dependence on probabilistic modeling of prepayment rates based on inputs such as interest rates, home prices and so forth. The models eventually fail, sometimes catastrophically, because no model can consistently forecast with accuracy the inputs. Even given correct forecasts of the inputs, prepayment speeds can depart from the forecast.

Our team does not rely on models; we rely on critical thinking. We start by working out what we think the returns will be for individual securities and ultimately for aggregated portfolios under various changes in interest rates over various timeframes – over a broader range of possibilities than we would considered under probabilistic boundaries of a model.

This process is labor-intensive. This is why we have a large team of portfolio managers, traders, analysts and information systems specialists devoted to the sector – some of us with three decades of experience managing through the cycles of the MBS market.

About Nordea Asset Management

Nordea Asset Management (NAM, AuM 216.8bn EUR*), is part of the Nordea Group, the largest financial services group in Northern Europe (AuM 311.5bn EUR*). NAM offers European and global investors’ exposure to a broad set of investment funds. We serve a wide range of clients and distributors which include banks, asset managers, independent financial advisors and insurance companies.

Nordea Asset Management has a presence in Cologne, Copenhagen, Frankfurt, Helsinki, London, Luxembourg, Madrid, Milan, New York, Oslo, Paris, Sao Paulo, Singapore, Stockholm, Vienna and Zurich. Nordea’s local presence goes hand in hand with the objective of being accessible and offering the best service to clients.

Nordea’s success is based on a sustainable and unique multi-boutique approach that combines the expertise of specialised internal boutiques with exclusive external competences allowing us to deliver alpha in a stable way for the benefit of our clients. NAM solutions cover all asset classes from fixed income and equity to multi asset solutions, and manage local and European as well as US, global and emerging market products.

*Source: Nordea Investment Funds, S.A., 30.09.2018

Nordea Asset Management is the functional name of the asset management business conducted by the legal entities Nordea Investment Funds S.A. and Nordea Investment Management AB (“the Legal Entities”) and their branches, subsidiaries and representative offices. This document is intended to provide the reader with information on Nordea’s specific capabilities. This document (or any views or opinions expressed in this document) does not amount to an investment advice nor does it constitute a recommendation to invest in any financial product, investment structure or instrument, to enter into or unwind any transaction or to participate in any particular trading strategy. This document is not an offer to buy or sell, or a solicitation of an offer to buy or sell any security or instruments or to participate to any such trading strategy. Any such offering may be made only by an Offering Memorandum, or any similar contractual arrangement. Consequently, the information contained herein will be superseded in its entirety by such Offering Memorandum or contractual arrangement in its final form. Any investment decision should therefore only be based on the final legal documentation, without limitation and if applicable, Offering Memorandum, contractual arrangement, any relevant prospectus and the latest key investor information document (where applicable) relating to the investment. The appropriateness of an investment or strategy will depend on an investor’s full circumstances and objectives. Nordea Investment Management recommends that investors independently evaluate particular investments and strategies as well as encourages investors to seek the advice of independent financial advisors when deemed relevant by the investor. Any products, securities, instruments or strategies discussed in this document may not be suitable for all investors. This document contains information which has been taken from a number of sources. While the information herein is considered to be correct, no representation or warranty can be given on the ultimate accuracy or completeness of such information and investors may use further sources to form a well-informed investment decision. Prospective investors or counterparties should discuss with their professional tax, legal, accounting and other adviser(s) with regards to the potential effect of any investment that they may enter into, including the possible risks and benefits of such investment. Prospective investors or counterparties should also fully understand the potential investment and ascertain that they have made an independent assessment of the appropriateness of such potential investment, based solely on their own intentions and ambitions. Investments in derivative and foreign exchange related transactions may be subject to significant fluctuations which may affect the value of an investment. Investments in Emerging Markets involve a higher element of risk. The value of the investment can greatly fluctuate and cannot be ensured. Investments in equity and debt instruments issued by banks could bear the risk of being subject to the bail-in mechanism (meaning that equity and debt instruments could be written down in order to ensure that most unsecured creditors of an institution bear appropriate losses) as foreseen in EU Directive 2014/59/EU. Nordea Asset Management has decided to bear the cost for research, i.e. such cost is covered by existing fee arrangements (Management-/Administration-Fee). Published and created by the Legal Entities adherent to Nordea Asset Management. The Legal Entities are licensed and supervised by the Financial Supervisory Authority in Sweden and Luxembourg respectively. The Legal Entities’ branches, subsidiaries and representative offices are licensed as well as regulated by their local financial supervisory authority in their respective country of domiciliation. Source (unless otherwise stated): Nordea Investment Funds, S.A. Unless otherwise stated, all views expressed are those of the Legal Entities adherent to Nordea Asset Management and any of the Legal Entities’ branches, subsidiaries and representative offices. This document may not be reproduced or circulated without prior permission. Reference to companies or other investments mentioned within this document should not be construed as a recommendation to the investor to buy or sell the same, but is included for the purpose of illustration. The level of tax benefits and liabilities will depend on individual circumstances and may be subject to change in the future. © The Legal Entities adherent to Nordea Asset Management and any of the Legal Entities’ branches, subsidiaries and/or representative offices.

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