Investors Are Bearish on Bonds

William H. Gross has dumped all Treasuries from the world's biggest mutual fund. Warren Buffett is shifting to shorter-term debt. Other bond market investors are moving money to non-U.S. bonds, real estate, commodities, and even a wind farm in Brazil as they prepare for an end to the three-decade rally in Treasury securities. "U.S. government bonds are not a safe haven," says Jim Rogers, the global investor who correctly predicted the start of the commodity rally in 1999.

The worry is that unprecedented spending by the U.S. government and the Federal Reserve will inevitably cause interest rates to rise, reducing the value of existing Treasury securities. (Bond prices fall when interest rates rise and increase when rates drop.) That would mark the end of a Treasury bull market that began in the early 1980s, after Fed Chairman Paul Volcker raised interest rates to as high as 20 percent to tame inflation. In the years that followed, inflation and interest rates declined, pushing up bond prices. The 10-year Treasury yield, which reached a high of 15.8 percent in September 1981, fell to as low as 2.05 percent on Dec. 30, 2008. That yield has risen to 3.36 percent as of Mar. 14.

Pimco said on Mar. 9 that Gross, head of the $237 billion Pimco Total Return Fund (PTTRA), eliminated government-related debt from his flagship fund in February as the U.S. projected record budget deficits. Gross, who has overseen the expansion of Pimco into a $1.2 trillion bond shop over four decades, predicted a year ago that "bonds have seen their best days." The Newport Beach (Calif.) company has opened a global stock fund and plans to start two others that invest in emerging markets.

Daniel J. Fuss of Loomis Sayles has expanded his investments in non-U.S. bonds and equity-linked securities. The $19.9 billion Loomis Sayles Bond Fun (LSBRX)d has been reducing Treasuries for more than a year in favor of high-yield bonds, says Kathleen C. Gaffney, co-manager with Fuss.

BlackRock (BLK), the world's biggest money manager, has moved to shorter-duration securities because of the potential for interest rate swings and is "underweight" Treasuries relative to benchmark indexes, Rick Rieder, chief investment officer of fundamental fixed income at the New York firm, wrote in a February investment commentary. Shorter-term bonds suffer smaller losses than long-term bonds when interest rates rise.

Insurers, whose flexibility to invest in different assets is limited by regulators, are buying bonds with shorter maturities to protect their investments from rising interest rates. Allstate (ALL), the largest publicly traded U.S. home and auto insurer, is sacrificing yield for flexibility on the $49.9 billion in fixed-income holdings at its life insurance division by acquiring shorter-duration bonds, according to Chief Executive Officer Thomas J. Wilson. "We are staying short in Allstate Financial, so that when rates come up we can reinvest at higher rates and lock in good long-term returns," Wilson, whose company is based in Northbrook, Ill., said in a Feb. 9 interview. "But that's costing us today in operating income."

Buffett's Berkshire Hathaway (BRK.A) brought the percentage of securities in its portfolio maturing in a year or less to 23 percent as of yearend, according to a Feb. 28 regulatory filing. That compares with 16 percent when the company started disclosing the duration of investments 18 months earlier. The holdings include Treasuries, as well as municipal, foreign government, and corporate bonds.

Liberty Mutual Group CEO Edmund F. "Ted" Kelly has decreased the percentage of fixed-income assets in the Boston insurer's $69.8 billion investment portfolio, while adding to equity and energy holdings. "To protect ourselves, we have been investing heavily in hard assets," Kelly said in a Feb. 17 interview. "We're a big holder of oil and gas, we're into mining and minerals, and we just finished wrapping up developing a wind farm in northeast Brazil."

The bottom line: Bond investors are preparing for the end of the long rally in Treasuries by shifting money into stocks, commodities, and real estate.

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