MFS Fund Top Performer After Ignoring Forecasts: Canada Credit

Three decades into the bull market for bonds, few forecasters projected that yields would continue to fall this year. Peter Kotsopoulos did.

The manager of Canada’s best performing bond fund, the C$600 million ($537 million) MFS Canadian Long-Term Fixed Income Fund, increased positions in longer maturity debt as forecasters clung to a 10-year Canadian government bond yield projection of 3 percent for 2014 through June. The yield on the benchmark security fell to as low as 1.98 percent yesterday, matching the 14-month low it reached in August.

“We typically don’t follow the crowd,” Kotsopoulos, 49, said by telephone from Toronto Oct. 7. “They told you bonds were expensive and look what they’ve done: long bonds have gone up 12 percent.”

Conflicts from Iraq to Russia and the spread of the Ebola virus will conspire to hold down global growth and bond yields, favoring bets on longer-dated debt sensitive to interest rate risk, Kotsopoulos said. His fund returned 12.1 percent this year through Sept. 30, the biggest gain among 78 open-ended Canadian bond funds that have assets of at least $250 million ranked by Bloomberg.

“Economic forecasts have been too optimistic compared with our forecasts,” said Kotsopoulos, director of fixed income for Canada at MFS Investment Management Canada Ltd., a unit of Sun Life Financial. “Structurally the way the economy is and the amount of leverage and the Fed’s position is conducive to low growth and inflation. Any back-up in interest rates is a buying opportunity.”

Central Banks

Investors pushed back bets for when the Federal Reserve will increase interest rates after slowing global growth was cited as a risk to the U.S. economy in the minutes of the Sept. 16-17 Federal Open Market Committee meeting released Oct. 8. Ten-year benchmark U.S. Treasury yields sank to 2.3 percent, the lowest since June 2013.

The Bank of Canada will probably keep its target rate at 1 percent through most of 2015, Kotsopoulos said. The rate is forecast to rise to 1.50 percent by the fourth quarter of next year, according to the median forecast of economists surveyed by Bloomberg News from Oct. 3 to Oct. 9.

“The Fed and Bank of Canada can stay in a position of avoiding raising rates for a generation,” he said. “If you look at what happened in the Japanese economy it’s been a generation of very low interest rates.”

Japanese Example

Japan’s central bank is struggling to free an economy bogged down in deflation and underwhelming growth that has become exemplified by negative bond yields.

Kotsopoulos has tempered some of his bullish bond bets by moving the average duration, which calculates how much prices change when yields rise or fall, of his fund closer to the 14 years benchmarks suggest. He has also put 1 percent of his fund into U.S. Treasury debt to hedge exposure to the Canadian dollar, which has declined 5.1 percent versus its U.S. peer this year.

“We reduced the portfolio’s sensitivity to interest rate movements,” he said. “We still remain overweight duration.”

Kotsopoulos’ fund, part of the $438 billion managed by MFS, outperformed the No. 2 rated SEI Long Duration Bond Fund managed by Beutel Goodman & Co., which returned 11.4 percent, and TD Asset Management’s Real Return Bond Fund, which gained 9.4 percent.

All three top-performing funds suffered losses in 2013, when Bank of America Merrill Lynch’s Canada Broad Market Index fell 1.5 percent.

Rate Risk

Canadian bonds have gained 7.1 percent this year, the best start to a year since 1995, Bank of America Merrill Lynch Canada Broad Market Index data show.

Economists are calling for North American economies to rebound next year, with 3 percent growth forecast for the U.S. and 2.5 percent in Canada. They anticipate 10-year bond yields will end the year at 2.45 percent and climb to 3 percent by the middle of next year.

Kotsopoulos said he’s ready to pare interest-rate risk further if the forecasts prove right this time. The fund’s mandate allows him to push duration two years above or below the index benchmark.

“Now that yields are lower we’re taking profits off the table,” he said.

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