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Investors have flocked to bond funds in a year marked by feeble equity markets, corporate crises, and microscopic interest rates following an unprecedented series of easings by the Federal Reserve. The Calvert Social Investment Fund: Bond Portfolio (CSIBX
), lead-managed by Gregory Habeeb since 1997, has been a prime beneficiary of the climate favoring fixed-income securities.
This fund has a twist, though: Unlike the vast majority of bond funds, Habeeb and co-manager Matt Nottingham must adhere to the rules of "socially responsible" investing that Calvert imposes on its family of funds. That means, among other things, that they shun investments in companies that they believe have poor records with regard to environmental and workplace issues or that make products such as weapons, tobacco, and alcohol. One other guideline: The fund tries to keep at least 95% of its portfolio in
investment-grade bonds, with an emphasis on corporate issues.
The fund's investing restrictions haven't hampered its results. For the 12-month period ended Sept. 30, the $166 million portfolio gained 5.2%, while the average intermediate-term medium-quality bond fund rose 4.9%. (In July, 2002, Standard & Poor's reclassified the fund's peer-group category to intermediate-term medium quality from long-term medium quality.) For the three-year period ended Sept. 30, Habeeb & Co. delivered an average annualized return of 8.1%, while the peer group gained 5.1%.
Palash Ghosh and Daniela Valle of Standard & Poor's Fund Advisor recently spoke with Nottingham and Calvert Chief Investment Officer Reno Martini about the fund's investing -- and social -- philosophy, and recent portfolio moves. Edited excerpts from their conversation follow:
Q: Through the first nine months of 2002, investors purchased $119.8 billion more of bond-fund shares than they cashed in, which trounced the full-year record for net new cash flow of $102.6 billion in 1986. Has this fund also attracted a sizable amount of money from investors?
A: We have seen almost a doubling in assets for this fund. We have not been surprised by the magnitude of the investing public's attraction for bond funds. The bubble burst for stocks way back in April, 2000, and it has taken a while for investors to move their money into fixed-income funds. At first, the low interest rate environment prevented them for investing in bonds. But as people became accustomed to low rates, they became more comfortable with putting money into bonds.
Q: How do you construct the portfolio?
A: By prospectus, our mandate is to have at least 95% of our assets invested in investment-grade (or better) bonds. So it's a high-quality portfolio. In addition, we are heavily focused on corporate bonds. We do not buy Treasuries, and we typically keep small positions in agencies and mortgage-backed securities.
In fixed-income investing, corporates tend to pay a higher coupon, which translates into strong returns. We typically want the income portion to be maximized, given what credit risk we are willing to take. We think that over time, corporate bonds will deliver a higher total return than either Treasuries or agencies.
Q: How do you execute on the opportunities you find?
A: We are "relative-value" traders. If we see bonds in the marketplace that we think will be valuable for our fund, we'll quickly purchase them. We also pay a lot of attention to the fund's
duration. Each quarter we set a target, and unless something drastic happens in the economy or with interest rates, we maintain that target duration.
We are very active traders. Our annual portfolio turnover rate for the 12-month period ended Sept. 30 was about 607%. We believe that our positive returns offset the increased costs incurred by our frequent trading.
Q: What's your current asset allocation?
A: As of Oct. 31, we had 34% in corporate cash equivalents, about 25% in corporate bonds, 24% in taxable municipal bonds, 5% in asset-backed securities, 3% in mortgage-backed securities, 1.5% in collateralized mortgage-backed securities, less than 1% in [issues from government] agencies, and 0% in Treasuries.
Q: In your corporate-bond allocation, which sectors have you been avoiding, and which have you been favoring?
A: We have avoided energy companies. They fail both on our social screens, as well as due to their credit risks. We have largely avoided the telecom industry, although we were hurt by some debt we owned issued by Nortel Networks (NT
). We initially invested in Nortel because we determined it was the premier telecom-equipment supplier, despite our negative outlook for the industry as a whole. Nortel suffered as telecom companies lowered their equipment expenditures. Sectors that we currently like are insurance and finance.
Q: Why does the fund have such a high stake in cash equivalents?
A: This sector primarily comprises short-term notes, commercial paper, etc. But yes, this is an unusually high level for us. With interest rates at historic lows, and the credit market the way it is, we decided to put more money into shorter-term securities. If you look at our maturity distribution, we currently have about 50% of our assets in securities with less than three years to maturity.
Q: Why have you moved into taxable municipals?
A: Over the last year, the taxable municipal market has grown. They are highly rated securities with good spreads to Treasuries. So, given the state of the credit markets, we think taxable municipals make a lot of sense: They have very little downside credit risk and they give the fund a very good income.
Q: What is the fund's credit profile?
A: As of Sept. 30, about 32% of our assets were invested in securities rated AAA. The fund's average credit quality was AA. We do have some exposure in below-investment grade securities because we can sometimes find value there.
In 2002, we have seen corporate credit get hammered. [Yield] spreads have widened. Eventually that situation will turn around. So if you have some securities with lower ratings, you will generate high returns from them down the line. However, we never buy any junk.
Q: What's your benchmark?
A: We have been using the Lehman Aggregate Bond Index as our benchmark. But we're recommending that we change it. That index is not really comparable to our fund, since it has approximately a 24% allocation in Treasuries, while we have no exposure there, and 15% or 16% in agencies, an asset class where we generally have a small position. We'll likely move into a benchmark that has a higher allocation to corporate bonds.
Q: Your fund has been outperforming your peer group but has been under-performing the Lehman index. Why?
A: This can be attributed largely to Treasuries, where we have no exposure. This asset class has done very well in 2002, as well as in 2000. On a calendar-year basis, the fund outperformed both the benchmark and the peer group during 1999 and 2001, and underperformed both in 2000. The fund's annual total returns for 1999, 2000, and 2001, were 0.7%, 6%, and 13.4%, respectively, compared with -0.8%, 11.6%, and 8.4% for the benchmark, and -0.7%, 7.7%, and 6.3% for the peer group.
Q: Does the social-screening process that you use in selecting fixed-income securities differ in any way from the stock-picking process employed by Calvert's equity funds?
A: It's pretty much the same. We will invest in companies that are environmentally friendly, have good labor relations, produce safe, useful products, and that are responsible citizens. We avoid investing in major polluters, nuclear power companies, and companies with a record of employment discrimination, or that make products such as weapons, tobacco, and alcohol, or that are involved in gambling operations.
Q: Were you surprised by the size of the reduction in the federal funds rate by 50 basis points [on Nov. 6]?
A: We were a bit surprised by the amount of the reduction. What surprised us more was in the wording of the Fed's statement, they were more worried about inflation, while the economists and strategists that we read are more worried about deflation and the economy going into recession. We think economic growth is anemic, but we don't think the country will go into another recession. As a result, I guess this reduction can't hurt, and maybe it will help the economy.
From Standard & Poor's Fund Advisor
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