At Brown Brothers Harriman (BBH), our Fixed Income team has generated industry-leading results across taxable and municipal strategies for over a decade. These results arise from a team and process that has proven effective through a multitude of market environments.

Everything we do – the way we structure our team, screen our universe, conduct credit research, apply buy and sell disciplines, and construct portfolios – is undertaken systematically with the objectives of preserving our clients’ capital and identifying value.

Our approach is rooted in two long-standing market features that create abundant opportunities for a valuation-driven manager:

• The additional yield provided by credit instruments is typically greater than their default costs.
• Bond valuations are usually much more volatile than their underlying fundamentals.

These features lead to several investment implications:

• First, bottom-up execution is paramount.
• Second, valuations and fundamentals should be assessed consistently.
• Third, a disciplined investor owns attractive assets when compelling credit opportunities are in short supply.
• Fourth, do not bet on unknowable criteria like the direction of interest rates.

Our fixed income process leans deeply on BBH’s long lending tradition and aligns with our clients’ interests. As you would expect from a prudent lender, we focus on our bonds’ underlying durability, not third-party credit ratings or what our competitors are doing. This mindset has allowed us to participate actively and confidently over the evolution of the bond market. BBH has participated in dozens of new structures in the municipal, corporate, and asset-backed credit markets, as well as countless inaugural issuances.

In this article, we cover the pillars of our investment philosophy that seeks to drive consistent performance through a variety of markets.

1. Bottom-Up Execution Is Paramount to Realizing the Benefits of Active Fixed Income Management

We build our portfolios one bond at a time, and our investment process focuses on a careful evaluation of each investment. At BBH, our analysts and traders are empowered like no other firm we know.

Each credit position (meaning a bond or loan that can default) must exceed our valuation threshold and is thoroughly researched, presented to the entire team, and approved unanimously by portfolio managers before purchase. Every position in every client portfolio results from this process.

2. Credit Valuations and Fundamentals Must Be Measured and Assessed Consistently

Across fixed income, we use consistent frameworks to assess valuation and credit fundamentals. This helps us stay disciplined and best manage the risks in our portfolios.

We apply our proprietary valuation framework to every investment. It provides a forward-looking estimate of return potential based on a security’s yield, quality, liquidity, and call risk. We also build in a margin of safety¹ based on the long-term volatility of similar investments. Doing so allows us to evaluate our opportunities on a level playing field. Without adequate safety margin, we don’t invest. We do not view volatility as risk, but rather as a generator of attractive entry points.

Regarding our fundamental analysis, we seek to identify issuers that have the ability and willingness to repay debts under a wide range of economic circumstances. We focus on a consistent set of criteria:

• Durability
• Defensive structure
• Transparency
• Effective management

We are committed to preserving our clients’ capital, and the consistent application of these criteria across every investment is critical. Following the same approach also fosters a strong ethos of teamwork, from the junior to the most senior team members.

3. Credit Concerns or Poor Valuations Are Reasons to Wait for Better Opportunities

We believe that there are two risks to credit investments:

• Credit deterioration, such as elevated risks of near-term defaults or downgrades
• Entering credits at unattractive valuations

We will sell a credit if we see credit concerns, regardless of valuation. We will also sell a credit that no longer offers positive excess returns vs. risk-free assets.

Our research and experience show that it is better to wait for the next attractively priced, durable credit instead of holding onto a poorly valued one. This approach aligns strongly with clients’ interests, as the intent is to reduce the portfolio’s risk instead of “reaching for yield.”

4. Construct Portfolios So Other Factors Have a Controlled Impact on Performance

As outlined, every investment we own is carefully researched and satisfies our valuation and credit criteria. A final step is assuring that the mix of exposures in portfolios does not create any unintended risks or concentrations that can overwhelm the performance benefits we expect to achieve.

This involves controlling the risk of interest rate movement vs. the strategy’s objectives, ensuring proper diversification, modeling risk factors, and maintaining similar exposures across client portfolios so that client performance experience is aligned with expectations.

Putting It Together

Our clients realize profound benefits from seemingly simple tenets:

• Valuations drive allocations, and our analysts and traders play critical roles in identifying and evaluating new opportunities.
• We employ a valuation framework that allows us to efficiently assess a broad range of opportunities across sectors.
• We pay careful attention to, scrutinize, and stress test each credit’s resilience and ability to withstand the unexpected.
• Our portfolios reflect our team’s best thinking, given guideline constraints, and may not resemble their benchmarks only in rate duration.

The Path Ahead

We are all pleased that bonds are back and once again provide a combination of income, liquidity, and diversification. Over the past decade, our strategies have prevailed through a range of challenges: record low rates, a pandemic, and the most aggressive tightening in generations.

We believe our bottom-up active management approach will remain effective, independent of what happens with interest rates. Looking forward, we are excited about new opportunities emerging from the retreat in bank-originated lending.² This is creating persistent opportunities in asset-backed securities, corporate bonds and loans, and commercial mortgage-backed securities. As always, careful bottom-up evaluation is critical to our success. We expect valuation cycles driven by investor fear and greed will continue, and we stand ready to capitalize as we march forward.

Conclusion

We believe that the combination of these beliefs – and the manner in which we execute them – allow BBH fixed income portfolios to not just add value, but also provide stability to our clients’ investment portfolio. These allow our clients to “sleep well at night” and focus their energies on their business and mission.