Thursday, July 31, 2014

Bond market veteran (Dan Fuss) is getting worried

The following is from the July 30, 2014, MarketWatch

Loomis Sayles’ Fuss: Geopolitical conflict and pricey market are a dangerous mix

NEW YORK (MarketWatch) — Dan Fuss hasn’t been shy about playing in the riskier corners of the bond market during his 50 plus years in finance. But he’s becoming increasingly cautious this year, reflecting growing concerns about the state of the credit markets.
Fuss’s flagship Loomis Sayles Bond Fund LSBRX -0.32%   LSBDX -0.32%   has put 27% of its $24.4 billion in assets under management in cash and reserves, such as short-term Treasurys, he said in an interview with MarketWatch this week. He joins a number of other big bond managers who have been prioritizing liquid holdings .

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Dan Fuss, vice chairman of Loomis Sayles & Co.
That decision reflects a mix of caution about geopolitical conflicts around the world that have so far gently pushed investors away from riskier debt securities. In the past month, Russia’s conflict with Ukraine has intensified, leading to harsher sanctionsfrom Western nations. Violence has alsoerupted between Gaza and Israel.
“I think it is a very good time to be cautious... You have growing geopolitical risks and you have shrinking incentives to invest.”
Dan Fuss
At the same time, credit markets have become expensive in recent years, exposing the market to the potential for a sharp reversal if investors run for the exits all at once. Fuss worries that mutual funds and exchange traded funds could get hit with big outflows, exacerbating the selling. Already, the junk bond market has shown some softness in recent weeks.
“I’m looking at the risks around the world and I’m looking at the direction they are going and I’m saying ‘this is really truly not good,’” Fuss said. “And then I’m looking at the markets and I’m saying ‘this is really truly full valuation.’ And so what’s the prudent thing to do? Well the prudent thing to do in the case of the Loomis Sayles Bond Fund is to say, ‘okay let’s get that liquid reserve up.’”
The rising prices on credit have pushed yields sharply lower on all sorts of debt, making it more difficult for investors to find securities that provide substantial income. Bond yields across the world have been hitting record lows, from U.S. junk bonds to German government debt. The silver lining for investors is that when the market is this expensive, you don’t lose as much by sitting out a round, says Fuss.
“I think it is a very good time to be cautious,” he said. “You have growing geopolitical risks and you have shrinking incentives to invest.”
JNK 41.06+0.11+0.27%
SPDR Barclays High Yield Bond ETF
Junk bond prices have risen sharply over the past year, as shown by this ETF's rise
Fuss has spent nearly four decades at asset management firm Loomis, Sayles & Co., where he is currently vice chairman. He pioneered its strategy of buying under-valued fixed-income securities, often in below-investment grade bonds. But the risk exposure in the Loomis Sayles Bond Fund, which he runs along with Matt Eagan and Elaine Stokes, has been coming down.
“By their standards, they are pretty conservative,” said Sarah Bush, senior analyst at Morningstar, referring to the current mix of assets in the fund. She likens the historical Loomis Sayles Bond Fund investing theory to value investing, in which market participants seek out undervalued securities.
The fund has outperformed 93% of its peers over the past decade, according to Morningstar. Last year, it managed to eke out returns of 5.5%, despite a 2% drop in the benchmark Barclays Aggregate index. Even after pulling back on higher yielding risk assets, Fuss’s fund has returned 6.9% year-to-date, compared with 3.9% gain in the Barclays Aggregate.
So where is Fuss accumulating returns within the market for highly liquid bonds? Increasingly, it’s in short-term debt, where the fund has been buying up liquid short-term U.S. and Canadian government notes. He asserts that by parsing the relative value of specific securities, investors can gain a surprising amount of income in this environment.
“It has put a premium on what I would call the mechanical skills of fixed-income,” he said.