Multi-factor high yield from BNY Mellon aims to reduce risk and boost alpha
BNY Mellon Investment Management’s high yield beta strategy emerged in ETF form with the recent launches of its first in-house ETFs.
Paul Benson, Head of Fixed Income Efficient Beta at Mellon, a BNY Mellon Investment Management affiliate with USD534 billion in assets under management, explains that the strategy has been running since 2012 in various different vehicles and currently has USD2.7 billion under management.
Part of the aim of the BKHY ETF launch in April this year, was to offer that strategy to a wider range of investors and at a competitive 22 basis points in fees.
Originally, the multi-factor approach to fixed income was more within the smart beta territory, Benson says.
“We were the multi-factor team and some of our products got a lot of traction,” he says. The result is the Fixed Income Efficient Beta team, which Benson heads.
“There are areas in fixed income which are difficult to trade and we see that where the passive and active approach are short of investor return goals,” he says.
High yield is a good example of this as passive high yield funds can be short of the benchmark simply through the management fees and transaction costs, as it is an expensive place to trade, he says.
“One penny can be the bid/offer spread on equities,” Benson says, “but in fixed income it can be a whole 1 per cent and upwards and that performance drag effects passive and active managers.”
So why buy high yield? “It’s such an attractive asset class because it has inefficiencies which compensate investors,” Benson says. “The benchmark is a heroic attempt to set your goals. It pushes the efficient frontier boundary with investors compensated for some of the inefficiencies such as downgrades, defaults and illiquidity.”
The traditional audience for Mellon’s high yield approach has been the larger institutional client base, large pension funds around the world and sovereign wealth funds.
“They have a lot of power in manager selection so they look for top managers in the high yield space, trying to find the managers that can deliver the best outcome for them,” Benson says.
“As data has become more widely available, investors have the benefit now of thinking: ‘How do you define that return solution, my returns net of fees given a certain level of volatility?’”
Investors don’t like to pay a lot of management fees for a small amount of alpha, Benson observes.
He describes his team’s approach as a solution that sits between passive and active, with a universe of 1,000 bonds, and security selection through the multi-factor approach, tilting the portfolios to the correct investment, without taking on significant risk.
“The Fallen Angel dynamic is one we understand very well so we can give a tailwind of alpha,” he says. “We have low volatility relative to the benchmark so it is more like a passive approach but we can also target benchmark returns net of fees because of the systematic active alpha component to it.”
The market falls earlier this year saw the strategy bearing up well. “It is not a strategy that should deliver surprises,” Benson says. “Even in a market that is tumbling, it will achieve the beta of 1.0 against the benchmark.”
Falls should be commensurate with the benchmark but rallies should be bigger, he says.
“March was a harrowing month as it was difficult to trade in that market with OTC markets entirely frozen, but we found different pockets of liquidity as we understood the credit areas so we could trade our portfolios and strategies without any issues. The strategy did exactly what it is supposed to do.”
The ETF, which has raised USD40 million since launch, is designed to offer the strategy to a broader audience within the ETF wrapper.
“The strategy begins with the recognition that diversification is extremely important in high yield,” Benson says. No discretionary decisions are made for the alpha part of the return.
“We rely on our analysis from our research group on factors such as quality and value to assess companies’ fundamentals. It’s akin to what a traditional analyst would do but on a model basis with oodles of data from across our entire database, examining a company’s leverage and margins to see how likely are they to be able to continue to service their debt to enable us to tilt towards better profiles and away from poorer profiles.”
Fixed income has fewer factors, just five key things: quality, value, momentum, carry and size and the team focuses on the first three.
The approach is agnostic of future downturns but spreads risk through a broad benchmark as high yield offerings tend to target the more liquid portion of the universe.
Benson notes that over the longer term, a crisis in the markets tends to result in a sharp downturn which equally rebounds sharply.