Bond Bulls Tethered as Biggest Losses Show You Can’t Ignore Math

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Bond investors burned by the biggest market reversal on record should buckle up. The second half of 2015 is shaping up to be no better.

That’s how Jack McIntyre, a money manager who helps oversee $66 billion for Brandywine Global Investment Management in Philadelphia, sees it. With yields worldwide within half a percentage point from the record low 1.33 percent reached in January -- and about $1.4 trillion of securities with yields below zero -- investors are being given little room for error.

“You don’t need a big move to ruin your day, or your year for that matter,” McIntyre said. “You can’t ignore that bond math.”

After European Central Bank stimulus efforts handed the global bond market a 1.9 percent gain in the first quarter, the debt suffered an unprecedented loss of 2.2 percent as investors prepared for the Federal Reserve to tighten monetary policy for the first time in nine years.

Fixed-income investors have never been more vulnerable to losses. Duration, a measure of bond sensitivity to interest-rate change changes, reached a record in April, according to Bank of America Merrill Lynch index data.

Market ‘Discontent’

The rout deepened in the past month after ECB President Mario Draghi said investors should get used to periods of higher volatility. After declines of 0.43 percent in May, the debt lost 1.2 percent in June as Greece’s debt crisis escalated and China faced its steepest stock-market declines since 1996.

“It’s setting up to be a season of discontent,” Raman Srivastava, the head of global fixed income at Boston-based Standish Mellon Asset Management Co., which manages $170 billion, said by telephone.

While uncertainty about global growth and subdued inflation may keep a lid on yields, they won’t protect investors from the whims of the market, and even small moves can weigh heavily on returns, Srivastava said.

“It won’t be slow and orderly,” he said. “There are still a lot of questions, there is still limited liquidity and that should ensure continued volatility.”

Yields on all types of debt globally have jumped to an eight-month high of 1.77 percent, according to Bank of America Merrill Lynch index data. A rise in German 10-year bund yields to 1.05 percent on June 10 from as low as 0.05 percent in April helped drag global borrowing costs higher.

‘Bond Bubble’

The yield on the benchmark 10-year Treasury note will rise to 2.54 percent by the end of the year as the Fed gets closer to raising interest rates for the first time since 2006, according to a Bloomberg News survey of economists. The yield is currently at 2.42 percent.

“The market is just waiting to take the medicine,” Paul Montaquila, the fixed-income investment officer at BNP Paribas SA’s Bank of the West, which oversees $62 billion in assets, said from San Ramon, California. “The ominous bond bubble theory is hanging over the market’s head, especially given the uncertainty of what things will look like once the Fed does start to move.”

Bonnie Baha says the bond market is oversold. “People are fearful of the rate rise but we are of the belief the Fed is on hold for the rest of the year,” said Baha, who helps manage $73 billion as the director of global developed credit at Jeffrey Gundlach’s DoubleLine Capital in Los Angeles. The market has been too bearish, she said.

Not ‘Tested’

Bill Gross, who departed Pacific Investment Management Co. in September, expressed concern this week that a decline in liquidity could exacerbate losses for investors during a selloff.

“Long used to the inevitability of capital gains, investors and markets have not been tested during a stretch of time when prices go down,” Gross wrote Tuesday in an investment outlook for Janus Capital Group Inc.

Global bond yields, which averaged 1.7 percent on June 29, are less than half their average of 4.85 percent during the past decade. That’s very little protection against rising rates, said Jim Caron, a money manager at Morgan Stanley Investment Management, which oversees $406 billion.

“It’s still early, but it would be hard to argue that we shouldn’t expect more of this given how very low yields are,” he said.

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