Shifting Yield Curve Presents Institutional Investing Opportunities

Winthrop Capital Management was founded in 2007 by Greg Hahn, president and chief investment officer.

Recalling the process of launching an independent advisory shop, Hahn tells PLANSPONSOR that his timing probably could have been better, given that Winthrop launched less than a year before the collapse of Lehman Brothers. But after navigating a few tough years for the industry, growth has been strong, and a steady stream of clients have come on board.

Winthrop offers multiple income-oriented strategies, managing taxable and tax-exempt strategies as well as portfolios customized to meet specific client liabilities or unique circumstances. The firm “builds these portfolios from the bottom up, starting at the security level,” Hahn explains. The portfolios are managed to maximize income and generate strong risk-adjusted returns within the context of the firm’s proprietary macroeconomic and interest rate outlook.

“It has been an interesting time to be focused on the fixed-income side of the portfolio,” Hahn observes. “We are just now, finally, getting back towards what people would generally consider a normal interest rate environment. It’s been some time since we have been in this situation.”

One broad message Hahn has for institutional investors, especially pension plans that are facing a difficult funding picture, is that there is “so much opportunity emerging out there that people are not pursuing as the fixed-income environment evolves.”

“For starters, the flattening of the yield curve is something we are discussing a lot with our institutional clients,” Hahn says. “We have seen an increase in short term interest rates and some widening in the spreads available. For us, as we build fixed-income portfolios, this means we don’t have to go as far out on the curve to capture some of the potential benefit of actively taking on interest rate risk. You can capture the exposures you need while staying within the one-year to five-year part of the curve. This has not been the case for some time.”

Stepping back, Hahn comments that the way fixed-income ideally works in a broader institutional asset allocation is to generate substantial coupon income. And then this coupon cash flow is what allows the investor to respond to shifting rates and reallocate the portfolio over time, capturing greater returns. This is a process that involves a lot of nuance and which deserves a lot of attention—as much as is paid to the equity side of the portfolio.

“For our clients and your readers, while they are sophisticated institutional investors, even they can struggle with all the challenges and opportunities, with the nuance,” Hahn observes. “It has been a while since we have been in this type of an environment, so they may not be thinking about the fixed-income side of the picture as closely or carefully as they should. That can present risks and opportunities.”

Hahn suggests he is “old enough to remember how the market was behaving in the 1980s and 1990s, when you could get 5.5% or 6.5% on the fixed income portfolio, and that was just the coupon.”

Institutional investors, at that point, did not really have to take on significant equity asset risk in order to grow their assets over time and meeting increasing liabilities.

“Today the picture is quite different, though we are slowly seeing rates increase,” Hahn says. “Today you have to use substantially lower fixed-income allocations to achieve the same kind of a reasonable return. Part of the broader challenge is that expected returns on equity assets are being compressed, which means that returns are depressed on the total portfolio.”

This will obviously be a big challenge in the decades ahead for pension funds, endowments, etc. It’s especially tough for pension plans and individual retirement savers given the countercurrent of peoples’ lifespans growing longer and the need to have more money to pay for health care in retirement.

Investment policies and separate accounts

Switching gears, Hahn points out that his firm these days does a lot of work on investment policy statement development. He says this is interesting work given how much it can vary from client to client. The policies his clients adopt range from the most simple to the most complex, depending on the size and maturity of the pension fund or endowment.

“When we start conversations about the investment policy, there is a natural focus on the equity side of the portfolio—clients often assume that is the more complicated part of the portfolio,” Hahn says. “After 2008, I understand why they would feel that way, but there is so much complexity and opportunity that is being overlooked.”

Among the biggest opportunities, Hahn says, is the growing availability of professionally managed separate accounts on the fixed-income side. These accounts allow Winthrop to take a custom tailored active management approach for each client.

“It can be advantageous to use this structure because you don’t run into some of the same liquidity issues that are present in a large pooled vehicle, which has implications for performance,” he says. “There are three areas where we believe active management can outperform dependably, and that is in small cap equity, international equity, and short-duration fixed income.”

This is particularly true in the short-duration fixed income arena, Hahn explains.

“An active manager in short duration fixed income can beat their benchmark pretty consistently,” he suggests. “We work with advisers and consultants to provide separately managed accounts [SMAs] across multiple custodial platforms. Each SMA holds individual securities that are for that specific client alone.”