A very low-profile privately owned Huntington Beach-based bond manager,Allegiance Capital Inc.,has in 13 years grown to become the second-largest bond manager in Orange County, next only to the mighty Newport Beach-based PIMCO Advisors LP.
The firm, which was formed in 1988 with less than $50 million under management, today has close to $2.1 billion and about 165 clients.
But there are reasons for its rise. Since its inception, the firm has beaten the Lehman Government/Credit Index for all but one year, when it trailed by a tenth of a percentage point. On average, while the index has risen by about 8% every year for the past 10 years, Allegiance’s bond portfolio has risen by 9.48%. Last year its portfolio was up 14.16%, while the index gained 11.85%.
“If you take our returns over the last 10 years, we are ahead of PIMCO marginally,” said Robert Southard, a co-founder of what now is PIMCO Advisors who is managing director of Allegiance. But, he said, “Our style of investing is exactly opposite.”
Allegiance is grouped in the core manager category. Core managers invest more than 90% of their funds in securities that are included in the Lehman Aggregate Index. PIMCO, on the other hand, is in the core-plus group, investing more than 10% in securities that are not in the Lehman index.
“It is fixed-income management but it is done so differently,” Southard said. “One of the best core managers is Allegiance, while one of the best core-plus managers is PIMCO.”
Southard said that last year, it beat the index by more than two percentage points because of few big bets that went in its favor. He said that when spreads started tightening between agencies (Fannie Mae and Freddie Mac) and the U.S. Treasuries, the firm quickly invested 30% of its funds in instruments of agencies. When spreads start coming down, prices of bonds normally tend to rise, giving capital appreciation to bond holders.
“The second big shift we make is looking at the structure of the yield curve,” Southard said. “The yield curve is, in our opinion, the most vibrant place to pick up excess return in the marketplace.”
He said that the average annual shift in the yield curve in the past 15 years has been 1.28%. “We try to play those shifts,” he said.
He said that by being a core manager, Allegiance does not speculate on the directions of the bond market and does not make many “bets.” The firm manages portfolios with investment grade corporate issues and for many clients the investment is restricted to AAA securities.
The bond manager offers three different styles of portfolio management, segmented by duration or correlation between a portfolio’s fluctuation and the change in the interest rates. Put simply, a duration of 5 would mean that a 1% rise or fall would lead to a 5% fall or gain in the portfolio.
Its Market Duration portfolio targets the Lehman Government/Credit Index, while its Intermediate Duration product targets the Lehman Intermediate Government/Credit Index. Low Duration Management, its third product, targets the Lehman 1-3 Year Treasury Index.
“We have a very straightforward approach to fixed income,” he said.
Southard said that he and others at Allegiance do not believe in timing the bond market as the portfolio managers feel that the short-term movements in interest rates cannot be accurately predicted. To eliminate timing risk, the firm’s portfolios are fully invested at all times, and to minimize default risk, it does not invest in junk bonds. Also, it buys investment-grade corporate bonds only and avoids foreign bonds.
“Our focus is to minimize risk,” said Southard.
Bill Mawhorter, Mark Torline and Kurt Phares founded the firm in 1988. In 1989, Southard left PIMCO Advisors to join Allegiance. Investment experience of seven professionals averages 23 years. n
