Janus Flexible Bond (JAFIX)

“Over the past two years, Janus Flexible Bond (JAFIX for ‘T’ shares) was the 10th best performer of every fund we track in our Performance Comparison tables. Its annualized gain over this period was 10.2%, vs. 6.8% for iShares Barclays Aggregate (AGG), an indexed exchange traded fund for the intermediate-term, investment-grade U.S. bond market.

“Flexible Bond is a so-called multi-sector bond fund whose consistently good year-to-year performance has resulted in a sterling long-term record. In 2008, when most funds with significant holdings of corporate bonds produced major losses, Flexible Bond produced a gain of 5.6%. The following year, when corporate bonds rebounded but government bond funds produced generally paltry gains, Flexible Bond generated a robust return of 12.5%. For all of 2008 and 2009, Flexible Bond produced a cumulative total return of 18.9%, vs. only 6.9% for the multi-sector funds tracked by Morningstar. Over the past five years, Flexible Bond’s annualized return of 6.6% places it among the top 7% of all the fixed-income funds we cover in the Investor. The fund is managed by Gibson Smith and Darrell Watters. Smith is the co-chief investment officer at Janus and the leader of the firm’s fixed-income products; he joined Janus in 2001. Watters is an experienced fixed-income trader and investor who joined Janus in 1993. …

“For Flexible Bond, Smith and Watters use what they call a ‘core-plus strategy.’ The ‘core’ part includes bonds in the Barclays Aggregate Index. The ‘plus’ part is represented by high-yield U.S. corporate bonds and floating-rate loans, which combined can account for up to 35% of assets.

“In fact, however, Smith and Watters have limited the fund’s exposure to high-yield bonds to a maximum of 20% of assets. That’s because, Smith says, they are centered on achieving consistent, superior risk- adjusted returns over time, which greater exposure to high-yield could jeopardize. The duo also limits volatility caused by credit issues by investing at least 20% of assets in Treasuries.

“Within these constraints, Smith and Watters vary the fund’s allocation widely among various types of U.S. bonds. While the fund could own a lot of conventional mortgage-backed securities, it currently has none; Smith and Watters don’t see any value there, because the yields on such securities are only very slightly higher now than those of comparable Treasuries. Currently, Smith says, he and Watters like U.S. Treasuries as well as U.S. corporate bonds, especially so-called crossover credits—the highest- rated high-yield corporate bonds, and the lowest- rated investment-grade corporate bonds.

“Flexible Bond was able to do so well in both 2008 and 2009 because Smith and Watters made astute allocation decisions with regard to Treasuries and corporate bonds. Though they have traditionally favored corporate bonds, Smith and Watters cut them to as little as 35% or so in late 2007 and early 2008, and raised holdings in Treasuries to 65%. Smith says he and Watters established those allocations when they noticed that corporate-bond buyers were accepting very poor terms for new issues, indicating high risk in the corporate-bond market. By mid-2009, Smith says, they had gradually increased corporate bonds to 70% of the portfolio, with only 30% in Treasuries.

“Smith says that the U.S. is likely in a cyclical period of low or even non-existent inflation, due to deleveraging here and in many other countries. Therefore, he says, Treasury yields are likely to be range bound near current levels, without a lot of risk of a huge upward spike any time soon. The fund is now about 35% in Treasuries, with the rest in corporate bonds.

“To pick the fund’s corporate bonds, Smith and Watters work closely with Janus’ equity analysts to estimate which issuers are effectively managing their businesses, limiting their debt or even deleveraging. [The managers] have been improving the quality of the fund’s corporate bond portion in recent months. In 2009, the lowest-quality bonds within the corporate market tended to perform best, as opportunities for refinancing corporate debt abounded and the rate of corporate defaults was not nearly as bad as the market feared it would be. However, yields have dropped so much on many of these bonds (because prices have risen so much) that they are no longer attractive, especially because some of their issuers still face difficult operating environments and are burdened with heavy debt loads. So, Smith and Watters have been moving from issuers in the retailing, metals and mining, technology and auto industries, which were beaten down in the crisis but have recovered significantly, to more bellwether, economically stable credits. …

“Interest-rate management is not a key driver of the fund’s returns. The managers attempt to keep the fund’s duration, which measures sensitivity to changes in interest rates, to within 15% of that of the Barclays Aggregate Index. So, interest-rate sensitivity is moderate. The expense ratio on the fund’s ‘T’ shares, available no-load through various online brokerages, is 0.75%. The current yield to maturity of the fund’s holdings is about 3.2%. The fund is suitable for all but the most conservative investors.”

Mark Salzinger,  No-Load Fund Investor

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