After a Disastrous Year, These Bond Traders Become World-Beatersby
Loomis Sayles is tops among total return funds with 5.3% gain
Russell, Eaton Vance also recover from dismal '15 to lead pack
At least for one quarter, Scott Service and his colleagues at Loomis Sayles & Co. can call themselves world-beaters.
After a forgettable 2015, when outsize positions in oil and commodities led to their worst year since the credit crisis, managers of the $1.54 billion Loomis Sayles Global Bond Fund have made a stunning turnaround. By betting big on banks and commodity producers during the height of this year’s global selloff, the fund beat 99 percent of rivals tracked by Bloomberg. Loomis is joined by Russell Investments and Eaton Vance, which had the second and third best funds. They all profited from beaten-down industries in the first quarter.
Naysayers might write that off as mere luck rather than skill. After all, just about every high-yield bond has rallied with commodity prices in recent weeks. But Service, a co-manager of the fund’s four-person team, is confident easy-money policies by central banks will keep riskier assets in demand for months to come. And regardless of whether the U.K. leaves the European Union, the fallout on the nation’s financial firms will be limited -- making bonds like those from HSBC Holdings Plc an attractive option.
“Bond investors need yield to meet their bogies,” Service said from Boston. “You’re going to see a greater demand for corporates” as government bond yields fall toward or below zero because of central-bank stimulus.
The fund has shifted away from U.S. Treasuries and other government bonds and now has almost 40 percent of its assets in corporate securities -- twice as much as its benchmark, Service said. More than 15 percent of the fund is invested in banks and insurers, higher than the 11 percent allocation in the Barclays Global Aggregate Index, data compiled by Bloomberg show.
Benchmark 10-year Treasuries were little changed in New York on Monday, yielding 1.77 percent.
The strategy helped the Loomis fund, which focuses on investment-grade debt but can also invest in junk bonds and emerging markets, return 5.3 percent in the first quarter. That’s almost three times the 1.8 percent peer average and tops among 189 similar U.S. debt funds that oversee more than $900 billion.
The ranking consists of open-ended U.S. mutual funds that are actively managed, oversee at least $500 million and able to invest across a range of countries and ratings categories.
Getting it right is crucial as yields on $8 trillion of sovereign debt have gone negative. Markets have been whipsawed as investors try to decipher the policy moves of the Federal Reserve, European Central Bank and Bank of Japan.
With Fed Chair Janet Yellen saying last week that the central bank will take a gradual approach to raising interest rates and the ECB adding corporate debt to its bond-buying program, Loomis’s Service is optimistic that company bonds will remain the most attractive investment.
Among the fund’s biggest winners has been Freeport-McMoRan Inc., the world’s biggest publicly traded copper producer. Its holdings of the miner’s 2043 bonds, which sold for less than 40 cents on the dollar at the end of January as commodities collapsed, have soared almost 40 percent. That’s about four times the gain for speculative-grade materials bonds over the same span.
Service said the fund added to its position in January and February because investors were pricing in a default scenario that wasn’t warranted and Freeport will be a survivor in the industry because of its low costs.
Standard Chartered Plc is another standout. While the London-based bank reported its first annual loss since 1989, its dollar-denominated subordinated notes due 2023 have returned more than 12 percent since mid-February, outpacing financial securities tracked by Bloomberg. They still yield 4.5 percent, about 3 percentage points higher than comparable Treasuries.
More stringent capital requirements “have made the financial sector safer from a bondholder perspective,” Service said.
That also makes U.K. banks, which have underperformed on “Brexit” worries, appealing because lenders such as HSBC and Royal Bank of Scotland Group Plc are unlikely to see their businesses hurt in any substantial way.
“Most of the U.K. banks have little to no meaningful presence on the continent, and those that do are very large, diversified, global players,” he said.
Keith Brakebill, who oversees the $1.64 billion Russell Global Opportunistic Credit Fund, took a slightly different approach to get to the top. The fund, which farms out money to several managers, beat everyone except for Loomis with a 4.5 percent return in the first quarter wading into troubled emerging markets such as Brazil and increasing its exposure to bonds of some of the lowest-rated U.S. corporate borrowers.
According to the firm’s website, Petrobras notes due 2023 are one of the fund’s top holdings in Brazil. They have returned about 20 percent since a low in mid-January, almost triple the average return for emerging-market company bonds tracked by Bloomberg.
“We felt that Brazil, particularly Petrobras, had gotten overly beaten up,” said Brakebill, referring to the state-controlled oil producer, which is at the center of a sprawling corruption scandal that’s rocked the nation. He added the firm increased its Petrobras position late last year and at the start of 2016.
And while Brakebill expects corporate debt to have a bumpy ride this quarter, parts of the market for triple-C tier U.S. company bonds are still undervalued relative to the risk. Moody’s Investors Service considers issuers in that category “subject to very high default risk.”
He declined to provide specifics, but based on disclosures provided on the company’s website, one of the fund’s biggest holdings in that tier is Ancestry.com’s payment-in-kind toggle notes due 2018. The debt, which gives the family-history research website the option to pay interest at a rate of 9.625 percent in cash or with more debt at a higher rate, has jumped above par after falling to a record-low 92.5 cents on the dollar in January.
Rounding out the top three is the $639 million Eaton Vance Bond Fund, which staged one of the industry’s biggest comebacks. After suffering a staggering 17 percent loss last year, the fund rebounded with a 4.4 percent return in the first quarter.
While still underwater over the past year, Kathleen Gaffney, the fund’s manager, credits the revival to sticking to her guns when markets were “overshooting” and pricing in a global recession.
“To us, the recovery was progressing here in the U.S., and we didn’t worry about a hard landing in China,” she said.
This quarter, Gaffney says the best opportunities lie in commodities and technology. The fund’s holdings include bonds from Southern Copper Corp., the miner controlled by billionaire German Larrea, and Seagate Technology Plc, one of the two biggest makers of hard disk drives. Both have rebounded since slumping to all-time lows earlier this year.
“I’m smiling a lot more,” she said. “Markets have simply changed their tune.”