"During 2019, we did shift our curve positioning a bit," Lake explained. "We were overweight at the front end (of the curve). And as the curve flattened, we moderated and became more curve neutral."
This approach worked. The $2.2 billion strategy returned 5.51%, which is especially impressive due to its emphasis on A to AAA-rated municipal issuances, according to Envestnet analysts, who selected it from over 200 qualified contenders. Plus, it outperformed the ICE BofA 1-10-year AAA-A Muni Index by 43 basis points. (ICE stands for Intercontinental Exchange, which bought Bank of America's fixed income index platform in 2017.)
Lake, who joined the firm almost three years ago, says the Breckinridge group looks carefully at downside risk as an investment-grade bond manager. Its research uses a bottom-up process, starting with fundamental analysis, such as reviewing financial statements and doing projections of revenues and expenses of each muni. Next, the team members determine "how [a bond's] budget looks and what kind of political situation environment they're in," and then they rate the bond accordingly.
The portfolio team also does proprietary ESG research. Using analysts tied to specific sectors "gives us a much better kind of color and insight into what matters from a credit perspective," she explained. Each sector analyst has developed his or her own proprietary ESG framework, which are taken from a variety of sources, such as census data or information on wealth dispersion.
"We look at all that data along with the fundamentals to get a more holistic view of an issuer and see what are some potential credit risks there could be that we're not going to see in the financials," Lake said.
"Whether it's a local community, a school district, a water and sewer issuer, we take those factors and integrate them into our view of the credits that we're investing in. One of the big big things we look at is climate risk, specifically, for municipalities," the CIO explained.
Unlike corporations, municipalities can't pick up and move, and these risks — from rising sea levels to inland flooding, hurricanes and heat stress — are taken into account when bonds are rated. The Breckinridge team does its own internal ratings, especially with regard to ESG risks, and uses those of outside rating, as well.
Cybersecurity risk was a particular focus last year, as ransomware threats ramped up. "We're seeing that more with local governments, where budgets might not be as high and cyber risk isn't [a priority]. But ransomware can shut them down for days," she said.
The team entered 2020 with caution, largely because of the aging stock market. "Then March hit, and all the excitement in bonds markets happened. We started doing stress tests sector by sector," the CIO explained.
"Think of a higher education entity on the municipal side with tuition, room and board and athletic fees all dropping. How can they withstand that?" Lake asked. "If the endowment drops, what is that going to look like? Those are the kind of tests we're running. The same goes for areas of the country exposed to oil [revenues]."
As for the COVID-19 pandemic, "We're well positioned [if there's] a second wave," Lake added. — Ginger Szala
