Neuberger Berman: Seeking diversified income source with resilience

This article was syndicated by Endowus in partnership with Neuberger Berman. 

Post-pandemic, the word “new normal” has been ubiquitously mentioned. When it comes to the interest rate direction, higher interest rates seem more like an ‘old’ normal. Fund managers and institutions alike see a minimal chance that the economy is heading back to another era of zero interest rates that lasted more than a decade. 

While slower growth and higher inflation can be seen as having some stagflation characteristics, we remain convinced that inflation and rates are trending lower. The message NB’s investment team took from the past months is that, while rates may stay high as we cover the last mile of excess inflation, it would take a considerable and persistent upside surprise in consumer prices to trigger another hike.

According to NB's fixed income research forecast, the Federal Reserve’s terminal rate will be in a 3 to 3.5% range by 2026. This implies a 1% real interest rate in the US with approximately 2% inflation.

Policy overhang persists

The path to the terminal rate is expected to be uneven, as the Federal Reserve’s policy timeline is still widely debated. Despite initial expectations of an interest rate cut in March 2024, such a move did not occur. Moving to recent developments, the return of persistent inflation has become a key concern for the market, complicating the Fed’s earlier plans to lower interest rates this year.

After 11 consecutive rate hikes, the increase in bond yields has attracted investors seeking income, yet risks persist. In the short term, the current level of higher real interest rates has historically been challenging for the US economy.

How can investors prepare for the risks associated with a volatile bond market? As more investors aim to secure stable income from fixed income, what strategies can they employ to manoeuvre through the fixed income market with flexibility, given the uncertain interest rates and macroeconomic landscape?

Siding with high-quality income-generating assets

Against the current backdrop, the Neuberger Berman Strategic Income Fund has adopted a cautious stance, significantly favouring agency mortgage-backed securities (MBS) and high-quality issues with a substantial overweight allocation. The fund’s goal is to maximise returns and income, assuming the volatility of higher-quality investment-grade issues. In this context, determining the right level of risk exposure is crucial.

A key focus area for the Neuberger Berman Strategic Income Fund is the US agency MBS. This asset class is known for its liquidity and absence of credit risk, supported by an implicit government guarantee. This makes agency MBS a resilient option under various economic conditions. Currently, agency MBS constitutes a major part of the fund’s portfolio, accounting for 48% of its assets.

Another strategy employed by the portfolio involves taking advantage of short to intermediate duration securities when they are undervalued relative to our expectations for the Federal Reserve's terminal interest rate.

The fund has shown adaptability in response to the overhanging Federal Reserve policies. Its allocation strategy has evolved from a bullish stance on high-yield credit in 2021, with investments at the lower end of the average credit quality spectrum, to the current more defensive allocation.

In the Strategic Income fund, in terms of credit quality, there has been a significant improvement; the average credit rating of the fund’s holdings has risen to A+ as of May 2024, up from BBB- in 2021. Today, the fund’s strategy differs from its earlier allocation, with a preference for investments that offer a contrast to the longer duration versus shorter mortgage bias.

Being risk-appropriate in a data-driven approach

Incorporating a flexible mindset into asset allocation enables the strategy to navigate through various cycles effectively. Here’s an insight into how this approach continually scouts the market for opportunities as a relative value investor. 

Neuberger Berman Strategic Income Fund deploys a monthly constant assessment of how the landscape and the opportunity set are changing in relative value terms. The portfolio managers are open-minded while being agnostic as to where those opportunities are. In other words, managers approach the screening process without any predetermined bias towards a specific sector or duration of the market. This rigorous approach helps investors pinpoint undervalued assets and position portfolios for potential outperformance.

Instead of focusing solely on predicting interest rates or any other economic gauges, the Neuberger Berman Strategic Income Fund prioritises understanding the 12-month forward return expectations across different asset classes. 

The model extracts a weighted average return of what a sector could deliver and works to corroborate a mathematical understanding of confidence level from the shape of that distribution of outcomes. Portfolio managers utilise a monthly screener that evaluates 60 sectors for their relative value, acknowledging that the market and the relative value of asset classes are always in flux. These expectations are initially presented as spot estimates but are further refined into a range of potential outcomes within each sector.

The framework is run on a recurring basis every month for the portfolio management team at Neuberger Berman to understand where relative value in the fixed income markets is today and how it's evolving as this is updated through time, and with these insights to position the portfolio to achieve its outcomes for that reality. 

This approach is particularly crucial given that the dynamics of the credit market often shift significantly as the economy approaches the later stages of a cycle.

Neuberger Berman Strategic Income Fund: Diversify your income source

In today's environment, marked by uncertainty and ongoing debates over Federal Reserve policies, this fund approach’s relevance becomes even more pronounced. The ability to adapt to changing market conditions and reassess value across sectors without a fixed outlook on interest rates is invaluable, especially when Fed policies are still subject to adjustments.

For a portfolio with income generation as its objective, the Neuberger Berman Strategic Income Fund could act as a diversifier. Because of its focus on the US debt market, it could be a complement to a regionally focused income fund or a broadly diversified global fixed-income fund. 

Neuberger Berman, founded in 1939, is a private, independent, employee-owned investment manager. The firm manages a range of strategies—including equity, fixed income, quantitative and multi-asset class, private equity, real estate and hedge funds—on behalf of institutions, advisors and individual investors globally. With offices in 26 countries, Neuberger Berman’s diverse team has over 2600 professionals.

Endowus has six funds from Neuberger Berman (as of 31 May 2024), including the Strategic Income Fund and the Short Duration Emerging Market Debt Fund. Get started building your own portfolio with these funds on the Endowus Fund Smart platform.