A disciplined approach to value in fixed income

Theme and Background

This chapter, in a Q&A format, presents the core framework of Harris | Oakmark’s fixed income head Adam Abbas for applying value investing principles to the fixed income market. The report emphasizes that this strategy does not rely on macro timing or yield chasing, but instead identifies bonds mispriced due to short-term market stress through bottom-up deep research.

Core Thesis

The author’s core investment argument is: The value in fixed income lies in buying bonds at a significant discount to their intrinsic value, which is assessed based on the issuer’s long-term debt repayment capacity (business durability, cash flow, balance sheet resilience, recovery prospects, and management capital allocation). A counterintuitive judgment is: Market volatility is not a risk, but an opportunity—when spreads widen and markets panic, the team tends to feel excitement rather than fear, and will shift funds from Treasuries and high-rated agency bonds to increase positions in their most favored credit bonds.

Key Arguments and Data

• Definition of Value: Value is the spread at purchase exceeding the fair spread corresponding to intrinsic value, i.e., “excess compensation for risk.” Such mispricing typically stems from short-term technical pressure or excessive negative sentiment, rather than long-term fundamental deterioration.
• Strategy Differentiation: Return sources are bottom-up concentrated credit selection and value-oriented asset allocation, rather than non-consensus duration or macro bets. Each position begins with fundamental credit analysis, not economic forecasts.
• Portfolio Construction: First identify the best credit opportunities, then size and structure positions based on risk-reward. Macro views never drive credit selection; portfolio construction only occurs after credit selection, balancing sector, quality, curve, and duration risks.
• Historical Performance: Since inception, the strategy’s best excess return periods have typically followed “risk-off” episodes, when measurable fear exists in the market. At such times, the team shifts funds from Treasuries, high-rated agency bonds, and highest-quality credit bonds to deploy into long-favored names.

Companies/Assets Involved

• Harris | Oakmark: The report’s subject, whose fixed income team collaborates deeply with the equity research team. The equity team’s profound understanding of management decisions and long-term fundamentals enhances the fixed income team’s ability to act quickly and confidently when market opportunities arise.
• Investment-Grade Securities: The strategy primarily invests in investment-grade bonds, aiming to achieve a low-volatility core enhancement strategy that can serve as a standalone or complement to core allocations.

Investment Implications

• Focus on Credit Selection, Not Macro Bets: Investors should avoid relying on short-term interest rate or macro forecasts, instead concentrating on company-level fundamental analysis to find bonds mispriced due to market sentiment or technical factors.
• Leverage Market Volatility: When spreads widen and markets panic, this should be seen as a window to add to high-quality credit positions, not to reduce risk assets. Historical data shows that such periods are often followed by the strategy’s best excess return phases.
• Emphasize Management Quality: Capital allocation capability and management decisions are key dimensions for assessing intrinsic value. Collaboration with the equity research team provides differentiated insights across the capital structure.