How to maximize bond returns

Andrew Kronschnabel, a portfolio manager at Logan Circle Partners in Philadelphia, is overweight in intermediate-level bonds to increase yield.

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“When you look across the credit quality spectrum of fixed income assets, the BB [and] BBB-rated component of the marketplace offers the best risk-adjusted return historically,” says Kronschnabel, who manages the Renaissance U.S. Dollar Corporate Bond Fund.

Higher-quality assets come at a premium. “There’s really only one direction for those assets to go, and it’s lower, in response to market volatility or a change in fundamentals or a change in investor sentiment,” he explains. “In very high-quality issuers, there’s oftentimes little upside.”

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For instance, this past year, assets with AA-credit quality returned 7.2%, single-A assets have returned 8.5%, BBB assets have returned almost 11%, and high-yield assets have returned 14.3%, as of early September.

That being said, Kronschnabel reminds investors that even though “the intermediate quality issuers offer more return, more spread and a higher level of yield, [that’s] because they’re riskier issuers. So it’s important to be careful when you allocate capital to this space.”

To make sure he’s choosing solid assets, Kronschnabel focuses on company fundamentals. “The markets tend to lead the credit-rating agencies, […] both with respect to credit upgrades and credit downgrades,” he says. “So, there are opportunities to invest ahead of credit-rating changes to securities in the portfolio.”

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If he sees the fundamentals of a high-quality company beginning to slide, he will sell before the assets are downgraded. “Additionally, one of the more rewarding opportunities is to be invested in what’s called ‘rising stars,’ or companies whose fundamentals are improving. Securities will reflect that fundamental improvement ahead of rating-agency action.”

When Kronschnabel sees a high-yield company with investment-grade metrics, he knows it will likely be upgraded in the future. “Once that happens, the securities are then available for purchase for a much wider set of investors and tend to trade up in price. So, if we can identify those rising stars and allocate to them in our client portfolios, there’s an opportunity for capital appreciation in fixed-income portfolios in addition to the spread carry that we get for owning these securities.”

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