Long Bond Rally Has Legs, U.S.'s Top Government Fund Saysby
Hoisington's U.S. Treasury fund outperforming peers this year
American Century zero-coupon fund ranks second in 2016
Hoisington Investment Management Co. has been riding the rally in long-term Treasuries for more than two decades, and it sees no bottom in sight for yields.
In a year when U.S. government debt is proving a haven for investors, the longest-dated Treasuries have delivered the biggest winnings. Thirty-year bonds have earned about 10 percent in 2016, almost double the gain on 10-year notes and triple the return for the Standard & Poor’s 500 Index, based on data compiled by Bank of America Merrill Lynch and Bloomberg.
The $394 million Wasatch-Hoisington U.S. Treasury Fund, established in 1986, has been well positioned for long bonds’ advance. As of the end of last year, it had practically all of its assets in Treasuries maturing from 2042 to 2045, according to data compiled by Bloomberg. The fund is tops among 43 government-focused U.S. funds with similar objectives, posting a 10 percent return this year, and it ranks in at least the 96th percentile on a three- and five-year basis, Bloomberg calculations show.
Founded in 1980 by Van Hoisington, the firm tends to buy long-term Treasuries when he and Lacy Hunt, who’s helped guide investments since 1996, predict inflation is in a long-term cycle of decline. They switch into mostly cash-equivalent securities when they have the opposite outlook. For now, the former approach is holding sway, with inflation below the Federal Reserve’s target since 2012. While a market-based measure of inflation expectations for the next five years is near the highest since July, it’s still well below its 10-year average. The biggest risk for longer maturities is that inflation quickens and erodes the value of coupon and principal payments.
“We do not believe the secular low in rates is at hand,” said Hunt, who began his career in 1969 as an economist at the Federal Reserve Bank of Dallas.“The economy is weak and inflation is contained, and as long as that continues we will make our mistakes from being on the long side of the Treasury market.”
Benchmark 30-year Treasuries yield about 2.6 percent, down from 3.02 percent at the end December and less than a half-percentage point above the record low of 2.22 percent, reached in January 2015.
Long-term yields have fallen even as the Fed raised interest rates in December for the first time since 2006. Slowing global economic growth combined with losses in stocks and commodities helped spark the decline. Amid the deteriorating outlook, the Fed has held off on boosting rates again. Traders see about a 50 percent probability of another quarter-point hike by December, although policy makers project as many as two boosts this year.
“We expect the current 30-year-bond yield low to be eclipsed over the next several years,” Hunt said. “The yield is going to sub-2 percent and may go down there and hold for a while.”
The aggressive view on long-term rates entails risk. Bond math dictates that longer maturities deliver the biggest returns when rates fall, and the steepest losses when rates rise.
The past three years demonstrate the potential volatility. Last year, the fund trailed 99 percent of peers, falling 2.84 percent, Bloomberg data show. In 2014, it earned 33 percent, putting it in the 97th percentile. In 2013, it lost about 17 percent, putting it at the bottom among similar funds.
“We take a multiyear view and our returns are very volatile,” Hunt said. “We don’t want clients that don’t understand our volatility.”
A fund with one of the most bullish strategies in the bond market ranks second this year behind Wasatch-Hoisington.
The American Century Investments Zero Coupon 2025 Fund has earned 6.1 percent, also benefiting from focusing on longer-term debt. It purchases strips: debt whose coupon payments have been stripped away and sold separately, leaving only the maturity payment for the holder. Bonds without coupons have higher duration, meaning their prices stand to gain more as yields fall.
The $197 million fund owns securities that mature around that date, including Treasuries and debt from government-sponsored enterprises such as mortgage giant Freddie Mac.
With the Fed slow to raise rates and U.S. yields drawing international investors, “we don’t see rates moving in any big way from here,” said Bob Gahagan, one of the fund’s managers in Mountain View, California.