Loomis Sayles Bond Is Back

If you owned Loomis Sayles Bond (symbol LSBRX) through 2008, you probably need no reminder of what a painful year it was. The fund lost 22.1% last year, trailing Barclay’s Aggregate Bond index, which is heavy on Treasuries, by 27 percentage points, and lagging the average return of similarly flexible bond funds by seven points.

After such an unexpected stumble, we went through a good deal of soul-searching as we considered whether to keep Loomis Sayles Bond in the Kiplinger 25, the list of our favorite no-load funds. Although we’ve always noted that this is a riskier-than-average bond fund, never did we imagine that it could take such a huge hit, even in a year as discombobulating as 2008 was for all sorts of investors.

Ultimately, though, we decided to stick with the fund and its lead managers, Dan Fuss and Kathleen Gaffney, and we hope that you did, too. Year-to-date through October 21, the fund is up 33.3%, which beats its average peer by eight percentage points and the Barclay’s index by a resounding 28 points. The fund’s long-term record remains solid -- its 8.9% annualized gain over the past ten years beats more than 90% of its peers.

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The same bets that bled red ink for shareholders in 2008 have gushed green in 2009. Specifically, the fund held a heavy stake in medium- and low-quality corporate bonds as markets hurled toward oblivion in the wake of Lehman Brothers’ collapse on September 15, 2008. Going into that month, the fund had nearly 50% of its assets invested in single-A- and triple-B-rated bonds (triple-B is the lowest rating that is still considered “investment grade”), and another 25% stashed in below-investment-grade securities, known as junk bonds. But in an about-face from 2008, lower-quality bonds have dominated in 2009: Year-to-date, the average triple-A corporate bond has shed 0.3%, while the average double-B-rated corporate bond has soared 40.6%.

But Gaffney says there’s little room for further price gains in much of the corporate-bond market, so she and her teammates are beginning to trim positions in some of their best-performing holdings. Relative to yields on Treasury bonds, Gaffney says, corporate-bond yields still look high on a historical basis -- an argument that implies higher prices to come in the corporate market. But Gaffney thinks Treasury yields must head higher in coming years, even if she and the rest of the Loomis team can’t pinpoint when that will happen. "We have probably passed the low in Treasury rates already," she says. "So we’ve been selling those securities with more interest-rate sensitivity and less room for price appreciation." With the proceeds from those sales, the team is, in part, reinvesting in short-maturity corporate bonds, which won’t suffer as much from a general rise in yields (bond prices move inversely with yields).

The team is also taking advantage of the leeway it has to invest in foreign bonds. The fund can hold as much as 20% of assets in non-U.S. and non-Canadian securities. It currently holds 15% in foreign bonds, with its largest weightings in Australia, Norway and Mexico. And it holds another 13% in Canadian securities. Gaffney says the team plans to opportunistically increase its stake in foreign bonds should it see any temporary weakness in attractive non-dollar currencies (U.S. investors holding securities denominated in foreign currencies benefit when the dollar weakens and suffer when the greenback appreciates).

Gaffney adds that the Loomis Sayles team is beginning to build a stash of dry powder with proceeds from sales so that the fund can pounce on unexpected opportunities that arise (the fund has 5% of its assets in cash). “The market is tricky right now, and we are expecting increased volatility” over the next few years, she says.