Joe Deane, a managing director and municipal bond fund manager at Smith Barney Asset Management Inc., can come on like a raging bull when the market has potential. By making aggressive interest rate calls and daring to take on substantive volatility, the seven municipal bond funds he manages, totaling $5.2 billion, have scored top long-term performances over the past decade.
While the vast majority of his competitors have come to adopt the use of indexed benchmarks over that same time frame, for a more tamed, calibrated exposure to sector and yield curve risk, today Deane continues to buck the trend.
Smith Barney capitalized on the hype surrounding Deane's management style in an advertising campaign that began running about one year ago for his $3.1 billion Managed Municipals fund. "Ferocious Market, Meet Your Match," read the full-page ad, which the firm had placed in major financial publications such as Barron's and the Wall Street Journal.
"When the market's in flux, he aggressively goes after potential opportunities," it reads, describing Deane as "undeterred" by volatility, and as a "warrior."
His critics credit him with consistency, although his management philosophy seems to stand in total contrast to their traditional notions of municipal bond investors' investment objectives to avoid risk and preserve principal above all else.
For all of their differences, however, Deane counters that there is very little disparity between the investment objectives in the prospectuses for his funds and those of his competitors.
All seem to promise the common goal of maximizing returns to the extent consistent with prudent investment management. In an interview with The Bond Buyer earlier this month, Deane discussed 20 years of managing municipal bond portfolios, and reiterated why he believes that he is delivering on his promises.
THE ART OF VOLATILITY
Peter DeGroot, a municipal bond strategist at Lehman Brothers, said he has seen an increased migration over the past several years among the tax-exempt institutional money management community to use of the firm's indexed benchmarks to assist in balancing the potential exposure to volatility in their own portfolios. That trend, exacerbated by interest rate volatility over the past several years, led the number of firms using the service, at least to some extent, to be now over 95%, DeGroot said.
But Deane disavows the homogenizing influences of indexing strategies. "I think if you're just managing a fund to try and not stand out, that's a pretty dull way to live your life," he said. "I think what people want is a well-managed portfolio. To me, closet indexing a fund means that you're actively striving for mediocrity, and I just don't understand that."
While, in theory, Deane's management style is quite simple -- going long, high grade, and weighting up in discount coupons to take advantage of a potential rally in rates -- for all the fanfare in his own marketing materials, he said that aggressive municipal portfolio management really has two sides.
"You can also be aggressive in being conservative," he said.
When he believes a market may have run its course, he reins in his average maturity and weights up in cash. And if there is a huge potential for downside in the market, don't be surprised to find out Deane's using futures contracts to defensively hedge the portfolio, because he has done it many times before.
"We've had some awfully good years when the market's gotten killed," Deane said, adding that being able to effectively weather bad markets is the key to successful money management.
"One thing I've learned over the years," Deane said, "the speed of a down market is probably three to four times the speed of an up. Markets go up in eighths and quarters, markets go down in points and points."
The reason you might call such plays aggressive is because rarely do they just constitute minor adjustments on the margins of Deane's funds. They can entail drastic turnovers of his portfolios.
Scoffing at the critics who warn him that the volatility must be limited at all times, "the only time, if you have a brain, that you want to limit volatility is in down markets," he said.
"When a market's going up, you want as much volatility as you can get," he added. And "nobody hates losing money like I do."
'VIVE LA DIFFERENCE'
Though averse himself to the bond market's storied volatility, Deane knows history well, and the industry's shift to the use of indexed benchmarks comes as no surprise to him.
In the bond market crash of 1987, Deane saw the market pay dearly for being long but not hedged. In 1994, the market was penalized for being overly leveraged and long in derivatives. In 1998, the market was both long and hedged, but still paid a high price when long bonds went down and short bonds went up.
"At the end of that, I really do think that Wall Street took a look at the business and said: 'You know what? We were long, we were dead. We were leveraged, we were dead. We were hedged, we were dead. I'm not sure I can I make money at this,' " he said.
The response, according to Deane, was that Wall Street committed less capital to liquidity in the bond markets, and began taking a much colder approach to fixed income in general.
Since then, the goal of many asset management firms has become a game of keeping investors in house by shielding them from short-term volatility in their most conservative investments, like municipals.
"I think there are a lot of senior managers out there who are more concerned about their next block of stock options than they are about the money that they have under management," Deane said. "I think the talent is out there to more aggressively manage money, but I'm not so sure that there are senior managers out there that are willing to give them the flexibility to run money in what I think would be a more professional manner."
At Smith Barney Deane is embraced, as the ad campaign attests. But by no means does the firm believe his way is the only way. Peter Coffey, a managing director and portfolio manager on another line of municipal funds at Smith Barney, practices more of an income-oriented style than Deane's total return strategy, preferring to hold onto bonds for their coupon income rather than aggressively alter the structure of his portfolio to take advantage of interest rates.
And the ad featuring Deane was part of a much larger campaign designed by the firm's marketing group that focused on close to a dozen different portfolio managers at the firm meant to emphasize their individual management styles.
"Vive la difference," said Deane. "For each portfolio manager there's going to be a different style to the way they manage money, and I think if you try and dictate it from on high, then you turn every single person that you have into an automaton."
"The ads have been extremely successful," said Edward Giltenan, global director of public relations at Citigroup Asset Management Inc. "Part of our job, since we sell through intermediaries, is not only to get the message out to the public at large, but to get the message out to the financial consultants who sell our funds ... and our share of mutual fund sales in those internal Citigroup channels has been steadily on the rise. The ad campaign has been one factor in that rising market share, but I think a very powerful one."
More importantly, however, Deane's long-term track record is uncontested. That, Deane said, is what really sells his funds.
Over the past 10 years, the A-class shares of the Managed Municipals fund are ranked first among national funds, having returned 115.6%, or 7.99% on an annualized basis, versus respective peer group average returns of 89.9%, or 6.6% annualized, according to data from Lipper Inc. Since Deane took over management of the fund, towards the end of 1988, the fund has nearly doubled in size.
'REALLY AGGRESSIVE'
The volatility in those returns is also evident.
The three-year, standard deviation of the A-class shares in the Managed Municipals fund are among the very highest of those in its peer group tracked by Morningstar Inc. at 5.54, indicating a very wide range of performance.
"We tend not to endorse Deane's approach for a lot of managers. We think it's really aggressive," said Eric Jacobson, a senior bond fund analyst at Morningstar. "Sometimes he's early with his calls, he's not going to be perfect every time."
"But I've been pretty good on the bigger picture of this marketplace a lot of years," Deane said.
Deane said that 1987 was the last time he was actually wrong on a market call. "I didn't realize how much downside potentially the bond market could have," he said. He wasn't the only one to make that mistake.
In 1999 Deane made a different kind of mistake, however, and the results were very costly. Deane said that going into that year he had despised the market and shortened his portfolios and bulked up in cash. Unfortunately, he opted not to hedge, coming off the famous collapse of a hedge fund run by John Meriwether at Long Term Capital Management in 1998.
By year-end, share classes of his Managed Municipals fund were showing up at the very bottom of the Lipper rankings, and that fund's assets alone were depleted by almost $1 billion.
The fund has yet to recover those lost assets. But "I think you learn from your mistakes, and I think that's one of the reasons people like having experienced portfolio managers," Deane said.
When wrong, "you get your head pounded off for a little bit," he said, but "you change your opinion."
When right, he produces sparkling returns, well ahead of the pack.
Thinking that the market had taken a beating in 1999, Deane began buying long at the beginning of 2000, getting prepared for what he thought would be a bull market in bonds. His Managed Municipals fund came out of the fray ranked fourth in the Lipper data by year-end, returning 15.6%.
"You have to have, number one, the courage of your own convictions," he said. "Number two, you have to have the patience to let the market do what it's got to do."
Skill number two is coming in handy for Deane this year.
The Managed Municipals fund is so far not living up to its top long-term rankings. During mid-June, the fund was ranked 95, according to Lipper, with the A-class shares returning only 1.94%, behind its peer group average of 2.31%.
But Deane, who is positive on the bond market, said he believes it has priced in too much economic optimism.
"I think before it's all over, you're going to get a very nice rally in bonds, probably into the fall of this year, spurred by at least one or two more drops in rates from the Federal Reserve Board ," he said. "If I think there's an opportunity to position ourselves for the next six months, I'm going to take that opportunity. I think the economy will recover, but I think it will take a little bit longer than people are hoping or anticipating."
As a result, he is keeping an average life of about 21 years right now. He is trying to keep the portfolio very high grade, mostly in plain-vanilla water and sewer bonds and general obligations. "We bought a lot of GOs, actually, in the last few months."
No one should be caught off-guard when a new rally sets in and the Managed Muni fund is back at the top of the pack. After all, the firm gave ample warning in its marketing materials.
"Don't be taken in by Joe's cool demeanor," his ad cautions. "Behind this muni maven's conservative facade lurks the heart of a true warrior."
