Loomis Sayles Bond has cut back dramatically on junk and emerging-markets bonds and has built up its position in safe Treasury issues. By Steven Goldberg, Contributing Columnist August 7, 2014 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. See Also: Mutual Fund Rankings, 2014 Advertisement 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.) Advertisement 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. Some bond funds currently see value in emerging markets. Not Loomis Sayles. As the Fed withdraws its stimulus, the managers believe developing-markets bonds will suffer. The fund has just 3% or so in emerging markets. Advertisement The managers aren’t anticipating a 2008-style catastrophe. Instead, Eagan says, the fund plans to buy back into the riskier parts of the bond market after they fall far enough in value to look attractive. “We’re not worried about junk-bond defaults spiking,” he says. “We’re more concerned about illiquidity in the market.” What does the fund own? As of July 31, it had 15% in investment-grade corporates, 31% in foreign bonds (mostly Canadian governments), 18% in junk, 16% in Treasuries, 8% in convertible securities and 6% in preferred and common stock. The average credit quality of the fund is triple-B, a bit higher than usual. The fund yields a historically puny 2.4%. Despite all those short-term bonds Loomis Sayles owns, the fund will suffer some if rates rise. Should they climb one percentage point, the fund’s price would fall by about 4%. Whether you own the fund or not, you’d be foolish not to pay attention to the fund’s dramatic portfolio shift—given Fuss’s long and superior record, as well as his customary aggressiveness. Advertisement Eagan adds a note of warning for stock investors. Junk bonds, he says, typically are “the canary in the coal mine” for the stock market. What’s more, he notes, stocks of small companies have already begun to sell off. Steven T. Goldberg is an investment adviser in the Washington, D.C. area.