April 13, 2022

Lipper Leaders Spotlight—Loomis Sayles Fund Achieves High Consistent Returns by Focusing on Cycles, Risk

by Mike Schnitzel.

The Lipper Inflation Protected Bond Funds classification is defined as funds that invest primarily in inflation-indexed fixed income securities, according to Lipper methodology. These funds are structured to provide protection against inflation.

The Lipper Leaders Rating System is a toolkit that helps guide investors and their advisors in selecting funds that suit individual investment styles and goals. According to Refinitiv Lipper, “Each fund is ranked against its peers based on the metric used (such as its flagship risk-adjusted return measure, Consistent Return, Total Return, or Expense), and the highest 20% of funds in each peer group are named Lipper Leaders, the next 20% receive a rating of 4, the middle 20% are rated 3, the next 20% are rated 2, and the lowest 20% are rated 1.”

Using Lipper Leader metrics for the month ended March 31, 2022, one of the best Inflation Protected Bond Funds is the Loomis Sayles Inflation Protected Securities Fund (LSGSX). The fund has a Lipper Leaders rating of 5 for the three-, five-, and 10-year Consistent Return and Total Return ratings, and it has beaten its benchmark—the Bloomberg US Treasury Inflation Protected Securities Index—over the three- and five-year periods to March 31. We spoke with fund manager Elaine Kan to examine the strategies she uses to manage the fund, and her outlook on inflation protected securities and Inflation Protected Bond Funds in general.

A focus on cycles

Kan said the fund’s management views the markets as driven by cycles and themes and seeks to optimize the portfolio to achieve better returns. She said it is very important for managers of Inflation Protected Bond Funds to understand inflation versus growth regimes. Inflation stood at about 7.9% in February, and Kan said inflation is expected to average about 6% this year. It is being exacerbated by war in Ukraine, which is affecting everything in the supply chain from wheat to batteries, and despite the Federal Reserve raising interest rates, rising interest rates cannot control supply shocks, she said.

“The situation bodes well for TIPS. TIPS outperformed Treasuries last year and over the past two months has outperformed other bond categories. We invest about 20% in non-TIPS, and we typically use credit to add additional alpha,” Kan said. “We believe countries around the world are always in different phases of the credit cycle—downturn, credit repair, recovery, and expansion. Our credit analysis reveals where different countries are in phases of the credit cycle. To us, it is very important to get the big picture right to understand inflation, growth, and the credit cycle phases.”

Achieving consistency, managing risks

Kan said the way LSGSX maintains its consistent returns is by focusing on the big picture. She said management looks at an entire business cycle when deciding how to proceed and prepare for different phases of the business cycle. “Things tend to smooth out, and sometimes in our business you can be right but slightly off on timing, and that can hurt in the short term,” Kan said. “But if you get the big picture right and stick to an investment process—and we take risk management very seriously—and figure out when it is time to hedge or add on risk, that all helps with consistency.”

According to Kan, there are three types of risk her team looks at when making portfolio decisions—duration risk, inflation risk, and liquidity risk. “For duration, we manage against a benchmark, so we can go long or short. For inflation, we tend to think of whether inflation will go higher or lower, and for liquidity, TIPS can get into a liquidity squeeze if the market is under a lot of stress,” Kan said. “We saw it in early 2020 and in 2008. When the market is under a lot of stress, people use Treasuries rather than TIPS as a hedge. Those three risk factors are always on our mind when we manage the fund.”

Optimism about near term for Inflation Protected Bond Funds

Kan said the market environment is very favorable to Inflation Protected Bond Funds in the near term. With growth expected to be flat or near flat, the market pricing in inflation, the yield curve flattening and the two- and 10-year and five- and 30-year Treasury yield curves recently inverting, returns for the broader market are likely to be down. “That bodes well for TIPS. I think TIPS will do very well in the short term,” she said.

Kan said Inflation Protected Bond Funds can help provide diversification for investors’ portfolios. “You want asset classes that aren’t always correlated in terms of their returns,” she said. “In different stages of the credit cycle and inflation you would favor certain asset classes over others. In an inflationary environment, TIPS is a good asset class. Stocks are good when there is economic growth.”

Investors poured money into Inflation Protected Bond Funds in March

The Inflation Protected Bond Funds classification had been neglected by investors, suffering from outflows of $1.3 billion year to date ended February 28. However, investors felt the pinch of inflation, rising gas prices, and war in Ukraine, and they reacted by pouring their money into Inflation Protected Bond Funds in March like gangbusters—to the tune of $2.7 billion in the U.S.

The same thing happened on a global basis, ex-U.S. Investors had withdrawn $2.3 billion from Inflation Protected Bond Funds year to date as of February 28. But in March, the classification experienced $2.9 billion in net inflows.

Longer term, Inflation Protected Bond Funds have been more in favor with investors. Investors in the U.S. have put $23.5 billion into the classification over the six-month period ended March 31. They put in $58.2 billion over the past year and $109.5 billion over the three-year period.

Investors globally (ex-U.S.) seem to share similar long-term sentiments with their U.S. counterparts about Inflation Protected Bond Funds. Over the past six months ended March 31, they deposited $9.3 billion into the classification. They moved $20.3 billion and $26.9 billion into the classification over the respective one- and three-year periods.

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