Kiplinger Today

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The Managers of a Top Bond Fund Turn Bearish

Steven Goldberg

Loomis Sayles Bond has cut back dramatically on junk and emerging-markets bonds and has built up its position in safe Treasury issues.

Since its inception in 1991, Loomis Sayles Bond (LSBRX) has been far friskier than the typical bond fund, often fishing for value in risky sectors that other fixed-income funds wouldn’t touch.

Not now. Founding manager Dan Fuss and co-managers Matt Eagan and Elaine Stokes have put 27% of the fund’s $25 billion fund in assets into short-term U.S. and Canadian government issues. Fuss says that’s the highest weighting the fund has ever held in such super-safe instruments.

The reasoning behind the move is simple, Eagan says: It’s increasingly difficult to find undervalued assets in any corner of the bond market. “Valuations across the spectrum are unattractive,” he says.

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What’s more, the market hasn’t, in the managers’ view, adequately priced in the geopolitical crises that have erupted across the globe, including those in the Middle East, Ukraine and the South China Sea, where tensions have flared over recent oil drilling by China in disputed waters.

On top of that, the Federal Reserve will soon end its massive bond-buying program and appears on the road to raising short-term interest rates next year. Eagan and his colleagues believe the long-term bull market in bonds, which began in 1982, is over, and that Fed action, combined with an improving economy, will push rates higher. Upcoming economic numbers will show “more robust growth,” Eagan predicts. Higher rates will mean lower bond prices.

Fuss has traditionally loaded the fund with high-yield corporate bonds, but Eagan says that junk is now one of the riskiest places in the bond market.

Indeed, junk bonds have already hit an air pocket. Since July 7, the yield on the Bank of America/Merrill Lynch US High-Yield Master II index has spiked from 5.3%, among the lowest levels in history, to 6.0% on Aug. 1, and the index price lost 2%. And Eagan thinks the decline has further to go. (All returns and yields are through August 5.)

Loomis Sayles Bond’s long-term record is superb. Over the past ten years the fund returned an annualized 8.3%—nearly double the return of the Barclays U.S. Aggregate Bond index.

But those returns have come with some big bumps in the road. In 2008, most notably, the fund plunged 22.1%, while the Barclays index, which is heavy on government-backed bonds, gained 5.2%. In short, when it comes to returns and risk, Loomis Sayles Bond has performed more like a stock fund than a fixed-income product. That’s because the fund has tended to hold large stakes in junk bonds and emerging markets, two categories that tend to mirror the performance of stocks.

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