Where to Place Bond Bets
You won't find many bond managers more seasoned or eclectic and global in their investing tastes than Dan Fuss, co-manager of Loomis Sayles Bond fund.
For example, Fuss currently has 30% of his go-anywhere bond portfolio in non-dollar assets, but virtually no holdings in such major currencies as the euro, British pound and Japanese yen. Instead, he has larger positions in bonds denominated in the Iceland krona, Indonesian rupiah and New Zealand dollar.
He bought U.S. Treasuries at the beginning of 2007, "not something we routinely do," as a sort of an "insurance policy." Treasuries were one of the bond market's best-performing sectors last year.
Fuss says he foresaw looming problems in credit markets and worried about deflationary pressures similar to those in Japan in the early 1990s. His fears eased a bit in the fall of 2007 when the Federal Reserve started cutting interest rates. Recently, he's been moving some of his U.S. allocation into investment-grade corporate bonds, including "strong triple Bs."
Only a fool would bet against Fuss, whose fund is a member of the Kiplinger 25. Since inception in 1991, Loomis Sayles (symbol LSBRX) has returned an annualized 11%. Over the five years to January 25, the fund returned an annualized 12%, an average of seven percentage points a year better than the Lehman Brothers Aggregate Bond index. Over the past year, the fund returned 8.4%. In 1997, Kathleen Gaffney joined Fuss on the fund; in 2007, Matthew Eagan and Elaine Stokes also became co-managers.
Fuss himself calls the portfolio a North American fund because there's no cap on how much he can invest in the U.S. or Canada (he currently has 12% of assets in Canadian dollar-denominated bonds). He can invest up to 20% of the fund in non-North American bonds.
He's avoiding the euro and the yen because, in part, he anticipates some nasty surprises from the European and Japanese banking systems, which are large holders (with less than transparent accounting) of bad assets from the U.S.
Fuss likes the economies and currencies of Canada, New Zealand and Australia, countries with relatively small populations, bountiful resources to export and governments with surpluses to fund retirement programs. He also has substantial positions in several Southeast Asian currencies, as well as the Mexican peso and Brazilian real.
But back to the U.S., for Fuss's view of the future is troubling. The Fed may keep cutting rates this year to avert a recession or deep slump, but after this phase, Fuss expects interest rates and inflation to increase. Why?
He says the federal deficit will start rising this year, surging from 1% of gross domestic product to 4% within a few years, due to expanding entitlement programs and an underfunded military. "When the U.S. Treasury becomes your borrower and you know it's coming time and again, it puts upward pressure on interest rates," he says. And a mounting deficit will cause inflation to rise.
Fuss says yields on ten-year Treasuries are headed to 9%, compared with 4% today. He says the picture reminds him of 1966-67, when the Fed could not take a tough line on inflation because it had to support the troops in Vietnam and the president with lax monetary policy.
He says a period of rising long-term interest rates and heavy government borrowing, which crowds out the private sector, will favor strong companies with good market shares in growing markets because their capital costs are much lower. Whether it's stocks or bonds, he says, "We're now in the early stages of a bond-pickers and stock-pickers environment that will run 16 to 20 years."