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Delivering Above-Benchmark Returns with Fixed Income Asset Management
MARC W. TOLLEFSON, Chief Investment Officer, joined Prime Advisors, Inc. in 2004
and is a member of both the executive team and the board of directors. He is
responsible for the firm’s overall investment process, which includes evaluating and
selecting securities, and constructing and administering portfolios managed by Prime
Advisors, Inc. Mr. Tollefson has over 30 years of securities trading experience in
multiple markets including municipals, corporates, U.S. governments, agencies,
swaps, money markets and futures contracts. Prior to joining Prime Advisors, Inc., Mr.
Tollefson was the Manager of long municipal portfolios for Quellos Fixed Income
Advisors, LLC. His responsibilities included long tax-efficient core fund and separate
account management. Prior to that, Mr. Tollefson was Vice President and Head Bond
Trader with GE Financial Assurance, where he managed a group of corporate bond
traders, traded both high-yield and investment-grade corporates, and executed over $30 billion in trades. Mr.
Tollefson was also a Principal with the Gelber Group, focusing on proprietary trading in U.S. Treasuries, strips,
agencies, futures and options, and worked for Benaroya Securities, Seattle First National Bank and the Federal
Home Loan Bank of Seattle. He received a B.A. in business administration from the University of Puget Sound.
SECTOR — GENERAL INVESTING
TWST: Could you provide an overview of your firm?
Mr. Tollefson: Sure. The firm I work for is Prime Advisors,
Inc. We specialize in fixed income. We do not actively manage
equities, but provide passive exposure to equities for a few clients;
however, the majority of our AUM is fixed income. We are a registered
investment adviser founded in 1988, targeting insurance companies
where we strive to be the asset manager of choice in the fixed income
space. We define ourselves as a crossover manager whereby we’re
looking to find out how profitable our insurance clients are expected
to be, and then attempt to maximize their after-tax income by using a
mix of taxable and tax-exempt securities.
Our clients all have customized portfolios; we do not have
funds. We utilize separately managed accounts that are not
comingled. We currently have 83 clients with the AUM recently
crossing over $13 billion. The largest percentage of those, let’s say
over 90%, are insurance companies. Each one of them has
customized portfolios based on that individual client’s objectives.
Often Prime will have a role in customizing and developing
benchmarks for that particular client. Then we use our Connecticut
team’s actuarial expertise to determine the appropriate duration
and the optimal mix of tax and tax-exempt allocations.
Following this interactive work with the client, the portfolio
construction will be implemented. Trade execution is conducted in the
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Redmond office where dedicated traders and research analysts reside.
Prime’s Disciplined Approach is implemented via a four-step process
where we use our expertise in an effort to deliver above-benchmark
returns for the individually managed portfolios. We have clients in
over 26 different states that are monitored by individual state
insurance commissioners. Each state has rules that each specific
insurance company must adhere to.
TWST: Why is insurance the focus? Also, describe a typical
client. Who would be suitable for your services?
Mr. Tollefson: We’re not targeting just insurance companies,
although those were our original clients. Our founder was a municipal
bond trader in Washington State back in the mid-1980s. He believed that
insurance companies were not maximizing their after-tax returns, that he
could blend his municipal expertise with an insurance expert and deliver
a better fixed income solution, one that would maximize the insurance
companies’ after-tax income by working with the companies to maximize
the use of municipal securities.
So he paired up with an ex-CEO of an insurance company on
the East Coast to supply the actuarial background to get that optimal
mix between taxable and tax-exempt securities to maximize the taxefficient bottom-line income for insurance companies. They saw a
niche that they could provide an opportunity/solution for insurance
companies. That’s where we got our start. It just grew up around
insurance, which is the majority of our business.
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MONEY MANAGER INTERVIEW ——————— DELIVERING ABOVE-BENCHMARK RETURNS WITH FIXED INCOME ASSET MANAGEMENT
We have a couple of mandates that we won recently
Once we understand what those goals are and understand the
whereby we have been approved on a particular platform for family
guidelines, we strive to deliver a total return package that’s going to beat
offices. We apply the exact same tools that I just discussed before
their benchmark on a net-of-fee basis. How do we do that? We call it
for the insurance companies, but in this case, for foundations and or
Prime’s Disciplined Approach. It is a four-step process that starts with
institutionally sized high-net-worth individuals, typically $25
our Investment Committee, which I head up. million to $100-plus million.
Every Monday morning, we get together with our investment
TWST: What criteria are used to assess a prospective
professionals and talk about the macro themes inherent in the fixed income
client?
markets. What broad parameters do we want
Mr. Tollefson: On the insurance side,
consistent across all the portfolios, what duration to
it’s going to be $25 million and above where we
target — long or short benchmarks — for the
Highlights
are able to aid clients in their cash flow modeling,
portfolios? What part of the individual sector’s
Marc Tollefson’s firm specializes
duration analysis and tax efficiency models. Cash
yield curve do we want to target to get the
in fixed income. Mr. Tollefson
flow analysis helps them decide how much
maximum roll down? What do we think the FOMC
details his firm’s four-step
duration risk they can take with a certain
is doing? What sectors might we want to avoid?
approach to investing, which aims
confidence level that cash flow from operations
An example of where we are avoiding
to deliver above-benchmark
and the portfolio would cover any claims
risk — specifically in the municipal sector — is
returns. The process targets
incurred. Even in a scenario where claims
Puerto Rico and the city of Chicago. We simply
sector and duration, security
frequency and/or severity increased, the client
opted to never buy Puerto Rico and are
selection and risk management.
would be confident that they would not be forced
underweight Chicago. The first step sets the broad
Mr. Tollefson says the goal is to
to sell bonds to cover claims.
parameters that all of our portfolio managers will
deliver on each objective while
Prime has clients that are less than $25
try to adhere to across their individual clients. The
maximizing the bottom line.
million. We welcome the opportunity to work
second step, sector selection, is when the
Companies discussed: Caterpillar
with startups and smaller companies where we
individual portfolio managers take the lead on
(NYSE:CAT); Deere & Company
can help clients achieve their specific goals and
their particular clients’ portfolios to determine
(NYSE:DE); JPMorgan Chase &
objectives. We share in their success if they
where to allocate the next dollar. What sector will
Co. (NYSE:JPM); Bank of America
grow. Sometimes those accounts can turn into
deliver the best after-tax returns with the least
Corp (NYSE:BAC) and Wells Fargo
$100-plus million clients.
amount of risk? Can the client benefit from
& Co (NYSE:WFC).
Just to give you an example of what a
municipals? Do they have duration room? Which
normal client would be, today I’m in Las Vegas at
particular sectors are going to get the best yield
a PIAA Convention — Physicians Insurers
and potentially deliver the best roll down?
Association of America — which is group of professional liability
Once the sector and duration is targeted we move to step three
insurance companies across the United States. There are a number of
in the process: security selection, which involves the trade desk. The
PIAA companies across the states. Prime manages money for 15 PIAA
PMs are going to work with the trader and research to find a specific
clients with $3.4 billion under management. We work with these
name in a particular sector. Prime’s dedicated traders work within the
insurance companies to invest their portfolios to support their insurance
universe of approved names searching for relative value within the
operations and to assure any claims can be covered.
parameters set forth by the portfolio managers. A corporate example
“An example of where we are avoiding risk — specifically in the municipal sector — is
Puerto Rico and the city of Chicago. We simply opted to never buy Puerto Rico and are
underweight Chicago.”
TWST: I see your aggregated mix by sector in terms of
your assets under management on your website, and it must be that
you have certain overweighting or underweighting for each client
or per client. Can you talk a little about how you make those
decisions, or where you’re currently trying to put your clients in or
steer them away within the fixed income model?
Mr. Tollefson: Absolutely. Because we don’t have that just
one fund, it does make it a little bit more difficult to talk about our
diversified portfolios. We first start by understanding the goals or
objectives of each one of those clients. We have to understand that
some of them are going to have constraints that others don’t. We have
clients who won’t invest out longer than one year, and we have clients
who invest all the way out to 30 years.
could be, “Is Caterpillar (NYSE:CAT) yielding more than John Deere
(NYSE:DE), if you look at the industrials in the seven years?” Caterpillar
might be coming with a new issue where we could get concession to the
market, so it would be picked over John Deere.
The traders interact with Wall Street in an effort to
deliver best execution. They are charged with shrinking the bid/
ask spread as much as possible, which lowers the execution cost
and enhances the client’s returns.
Step four of Prime’s Disciplined Approach is risk management.
This includes the ongoing monitoring and measurement of the portfolios.
It includes attribution of all our holdings: What is working? What might
not be working? Do we need to be proactive to reduce a particular risk?
Or is there an opportunity to add to a position at better levels?
MONEY MANAGER INTERVIEW ——————— DELIVERING ABOVE-BENCHMARK RETURNS WITH FIXED INCOME ASSET MANAGEMENT
That’s Prime’s four-step process of constructing client
portfolios: the investment committee, sector selection, security selection
and then monitoring/risk management; the goal being to deliver on each
client’s individual goals and objectives while attempting to maximize the
bottom line on an after-tax basis.
TWST: When you look at the insurance clients that you
have on aggregate, where do you see yourself generally over time
overweighting and underweighting, and why?
Mr. Tollefson: That’s changed over the last couple of years.
For fixed income, our normal turnover is roughly 20% to 25%. We are
always looking to add book yield into the portfolios; it’s going to support
our insurance company’s operations. They don’t want to see a whole
bunch of gains that they will be forced to pay taxes on, especially if it
hurts income on a go-forward basis.
But specific to your question about sector allocations, about a
year ago at this time the markets got very, very frothy. We were
significantly overweight corporates and municipals. In particular, the
front end of the curve — inside of five years — became extremely tight,
and we started selling into that. Absolute yields were low, and risk
premiums were trading through prefinancial crisis levels. We saw this as
an opportunity to sell and started reducing our corporate overweights
from 15% to 20% overweight to current 5% to 10% overweight.
Municipals also got extremely rich. We sold off.
increase in one-time dividends to shareholders, share buybacks, and
increased merger and acquisition risk. These actions, by definition, are
increasing the leverage within the corporate market. They are the
opposite of what was happening in 2008 when they were cutting costs
and deleveraging balance sheets.
Leverage can cut both ways. The financial metrics are not as
strong as they were, and we are being more cautious. We’re not running
away from corporates — we are still overweight — but we’ve stayed in the
top-tier names within the ratings buckets. We are not dipping down into the
third- and fourth-tier names just to pick up a couple of extra basis points. On
a risk/reward basis, we don’t think that we’re being paid for it.
TWST: Can you talk about those names? Which are the
names you’re talking about?
Mr. Tollefson: For finance it would be JPMorgan
(NYSE:JPM), Bank of America (NYSE:BAC) and Wells Fargo
(NYSE:WFC); those are names that we’re going to focus on. As far as
specific names, we have dedicated traders following the markets day in
and day out. They are charged with finding the best relative value for
specific names in their sectors. The portfolio managers will direct the
sector and duration, but traders will know what is trading rich/cheap and
execute accordingly. They have specific directives set by the Investment
Committee — Step I — but are given latitude within the approved names
reviewed and approved by our research team.
“We have started to see a shift in corporate America. They are becoming much more equity
friendly in nature. We have seen an increase in one-time dividends to shareholders, share
buybacks, and increased merger and acquisition risk.”
So if you look at allocations today, we remain underweight
Treasuries, are neutral agencies, marginally overweight corporates, both
taxable and tax-exempt municipals, underweight mortgage-backed
securities, and overweight asset-backed securities. We were significantly
overweight in spread product; we have reduced those allocations to lock
in gains, and are currently more conservative in investing the next dollar.
We will wait for market dislocations to develop and then potentially have
a better entry point for adding more risk.
TWST: Can you talk a little bit more about the corporates,
and why you said you’re moving a little away from that?
Mr. Tollefson: Corporates are a sector we’ve liked since the
financial crisis. In the midst of the financial crisis corporations were
forced to cut expenses to offset poor sales in the recession. They were
forced to cut expenses and shore up balance sheets; companies fired
people, cut expenses and sold nonperforming assets. All of those
things created a deleveraging in corporate America, which is good for
fixed income securities.
Prime saw a very good opportunity to own selective corporate
names that had their risk premiums gap out during the crisis. These
selective credits had management teams doing all the right things to cut
costs and stay solvent. Over the last couple of years, spreads have
continued to tighten, in some cases to pre-crisis levels. For this reason
we cut back our overweights to the sector.
We have started to see a shift in corporate America. They are
becoming much more equity friendly in nature. We have seen an
TWST: You talked about benchmarks. When you
mentioned that word, are you talking about ones that you
developed internally, or is there an external benchmark that
you’re commonly using?
Mr. Tollefson: Typically benchmarks always come down to
some component of the Barclays Aggregate. The Barclays Aggregate can
be split up in all sorts of different manners. Some benchmarks will come
directly from clients. Larger clients probably have a consultant that they
work with that will tell you what that benchmark is going to be. Some of
the midtier companies might ask us to help them come up with a
customized benchmark.
As I mentioned, our Connecticut office houses our investment
strategists who are steeped in actuarial-based insurance knowledge. They
can run cash flow analysis and show a number of different models to allow
a client to get comfortable with how much duration to take. In that case we
supply them information and then they take that under advisement, decide
what duration and/or benchmark they are comfortable with, then pick an
appropriate benchmark. Our Connecticut team conducts client modeling on
an annual basis to confirm the existing allocations and benchmarks are still
appropriate for the client and their needs.
TWST: On average, can you talk about what performance
you’ve been able to achieve against benchmark?
Mr. Tollefson: Last year was a very successful year. I think we
beat probably 98% of our benchmarks on a net-of-fee basis. Our
overweight to spread product and the drop in interest rates assisted in
MONEY MANAGER INTERVIEW ——————— DELIVERING ABOVE-BENCHMARK RETURNS WITH FIXED INCOME ASSET MANAGEMENT
delivering positive above-par performance. With 83 clients and over 150
separate portfolios, we don’t have a clean “fund” that we can measure
our performance against. Specifically, our decision to remain neutral
duration, our curve positioning, the overweight to corporates and
municipals, and taking chips off the table in the middle of 2014 proved
very advantageous for performance across our diverse client base.
TWST: If an insurance company is considering using your
firm, what would you say to them in terms of helping them to
appreciate the complexity of the investment decisions for the
insurance firms? Can you describe why they would need to hire a
firm like yours, and what are the particular considerations that
insurance company should be looking at?
Mr. Tollefson: For a normal RFP process the insurance
company does not want to manage the money internally, so they have to
find a partner to work with, one they can trust and are confident will
deliver on the specific needs of the insurance companies. That’s where
Prime comes in. We learn about that particular prospect, get as much
information as we can regarding their business, risk tolerances, goals and
objectives. With all that information, we attempt to construct a portfolio
that will maximize the after-tax yield/return of a particular portfolio
while taking prudent risks.
For many prospects we conduct all of this work prior to
winning the business. We download their portfolios, review all of their
holdings and compare them to our investment ideas. We then show the
prospect how we can potentially add returns/income. It could be said that
we deconstruct what they currently hold, overlay our ideas and show
how we can improve on asset mixes, duration management, yield curve
positioning, credit risks and/or liquidity, all with the intent of maximizing
returns on an after-tax basis.
Our goal is to be looked at as the investment team down the
hall. A prospect should expect a money manager to listen and deliver.
That is Prime’s goal. We are a singles and doubles hitter; we don’t swing
for the fences in our portfolio management. We strive to deliver
consistent above-benchmark returns while protecting against loss of
principal. That is what I believe an insurance company should be looking
for in a fixed income money manager.
TWST: What advice do you have for investors who are
looking at fixed income, and can you talk about the macro trends
that would affect that investment class, like interest rates?
Mr. Tollefson: I expect volatility. I’ve been in fixed income
trading and portfolio management for 33 years now. Since the financial
crisis in 2008 to 2009 the markets have changed. The actual size of the
bond market has ballooned, while those making markets in the bond
market have shrunk. Lehman is gone, Bear Stearns is gone, and Merrill
is part of BofA. You also have all sorts of new regulations — Dodd/
Frank, Basel III, Volcker Rule — that have curtailed the amount of risk
the remaining broker/dealers are willing or able to take. These changes
coupled with low absolute rates and compressed risk premiums are going
to create more volatile moves in the market. Wall Street simply will not
act as the buffer they have in previous years.
As for rates, the FOMC is much closer to raising rates now
than over the past number of years. Normalization of rates should be
viewed as good thing. Over the long haul getting the central banks out of
the markets will be a positive. We continue to remain neutral duration
versus our benchmarks, but have done a number of tactical trades that
should position our portfolios in a manner to beat our benchmarks if rates
do normalize. We have less negative convexity — extension risk — in
both our mortgage-backed securities and municipal holdings. We also
believe our overweight to spread product over governments will provide
a buffer against rising interest rates.
At the end of the day a gradual increase in rates will be good
for our insurance companies. Income has decreased as rates have been
pushed down, and reinvestment yields cannot replace current book yields
with prudent risk. Other macro risks include where we are in the credit
cycle. I mentioned earlier how companies have become more shareholder
friendly; we are watching this carefully.
Lastly, because we are a crossover manager that focuses on
after-tax yields, we need to keep an eye open for tax changes and
potential impact on our tax-exempt municipals. We are not concerned
about moves in 2015, but as the presidential elections approach more tax
chatter could develop.
TWST: And is there anything you wanted to add before we
end that we haven’t covered?
Mr. Tollefson: I think we have gone over quite a bit. I would
wrap up where we started. Prime Advisors, Inc. is a dedicated fixed
income asset manager. We have 83 clients, over 150 separate portfolios,
and over $13 billion of assets under management. We are not a fund, but
rather work with individual clients to develop customized portfolios to
deliver on specific goals and objectives. Our goal is to deliver abovebenchmark returns and be considered by our clients to be the investment
team down the hall.
TWST: Thank you. (KJL)
MARC W. TOLLEFSON
Chief Investment Officer
Prime Advisors, Inc.
Redmond Ridge Corporate Center
22635 NE Marketplace Dr.
Suite 160
Redmond, WA 98053
(425) 202-2000
www.primeadvisors.com
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