Wall Street’s Bond Contrarians Lose Out as Market Rallies

Wall Street’s top bond traders get paid millions of dollars a year to outsmart the masses.

They’re not earning their pay so far this year.

Hedge funds that largely invest in corporate debt returned 4.1 percent in the first five months of 2014, according to data from Hedge Fund Research Inc. That’s less than the 5.5 percent they would have gotten if they’d sunk their money into a broad index of company bonds.

The performance gap is just as pronounced for non-traditional mutual funds that buy debt and allow managers to take unconventional views. On average, they’ve eked out gains of 2.5 percent in 2014, Morningstar Inc. data show. Then there’s BlackRock Inc.’s $255.9 million Bond Allocation Target Shares Series P fund, which seeks to provide a hedge against rising benchmark rates. It’s lost 3.6 percent this year, according to data compiled by Bloomberg.

Central bank’s money-printing policies worldwide have made it hazardous to be a contrarian even as government and company bonds look overpriced by most historic measures. Just as the Federal Reserve is curtailing its bond purchases in the U.S., the European Central Bank is considering starting a similar program, fueling an increasingly global search for higher yielding assets.

Staying Bearish

So the bet that keeps on winning is simply buying bonds of almost any kind.

Wall Street’s biggest banks have suffered losses as a result of some of their bets against Treasuries this year.

For example, on April 30, the 22 primary dealers that do business with the Fed had a net $10.3 billion worth of bearish wagers on Treasuries maturing in three to six years, meaning they’d profit if the notes lost value. Instead, similarly dated debt gained about 0.7 percent, and the banks have unwound most of those short positions since then, according to Bank of America Merrill Lynch and Fed data.

Others are also giving up on betting against the market. On June 6, investors yanked $42.6 million from ProShares’ $4.3 billion exchange-traded fund that uses leverage and derivatives to give buyers inverse returns of long-dated Treasuries. That was the biggest daily withdrawal in about three months.

Such capitulation suggests that when yields do start to rise, investors will crowd into the exits and exacerbate the selloff. Economists surveyed by Bloomberg still expect benchmark 10-year Treasury yields to rise to 3.17 percent by year-end, from 2.6 percent today.

And therein lies the big danger of 2014: That all skepticism is flushed out of the market just when those contrarian voices are needed the most.

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