20
There has been much discussion of bond-fund
managers increasingly investing beyond the confines
of the high-grade U.S. bond market in recent years.
Yields on high-quality U.S. bonds have plumbed new
lows, pushing investors into relatively higher-
yielding sectors such as emerging-markets bonds,
junk corporates, and nonagency mortgages.
Prominent managers such as
PIMCO
’s Bill Gross have
also made widely telegraphed moves in this direction,
particularly in diversifying among ”clean dirty shirt”
developed- and emerging-markets sovereigns. And as
my colleague Eric Jacobson noted previously, correla-
tions between actively managed bond funds and
the Aggregate index have been on the decline since
2008
’s credit crisis.
While some core bond funds are certainly following
the prompting of the Federal Reserve (and the Bank of
Japan, the European Central Bank, and the Bank of
England) into riskier territory, the trend may be over-
stated. For one, correlations between certain bond
sectors and the Aggregate index—including invest-
ment-grade corporates and agency mortgages, which
make up close to half the index combined—have
themselves declined in recent years, while the index’s
correlation with Treasuries has risen. That partly
reflects the changing composition of the Aggregate
index, as the Treasury department’s bond issuance
has outpaced that of other eligible sectors. Treasuries
currently account for
36%
of the index, up signifi-
cantly from just
22%
at the end of
2007
.
Given those dynamics, active bond funds could have
seen their returns deviate from the index’s to a larger
degree in recent years without making dramatic
changes to the composition of their portfolios. Also,
there are signs that valuations on some non-Treasury
sectors are starting to look less attractive, particularly
now that a significant portion of their yield advantage
has eroded over the past year. At the beginning of
2012
, for instance, high-yield corporates, battered
about by fears of a eurozone crisis contagion, offered
an additional
750
basis points in yield over Treas-
uries, on average, which made them cheap relative to
historical norms. As of April, though, that gap has
narrowed to less than
500
basis points, while the
sector’s average absolute yield has reached record
lows of less than
6%
. For funds that stay in the
investment-grade arena, the debt of large financial
firms has been a popular bet for similar reasons.
But since the start of
2011
, the yield spread on the
financials sector has dropped to
140
basis points
from nearly
350
.
For several noteworthy bond-fund managers, price
moves like these have given them reason to begin cut-
ting back their exposure to non-Treasury areas. For
instance, while the team at
Metropolitan West Total
Return Bond
MWTRX
still has plenty of out-of-index
exposure to the nonagency mortgage market, the
fund’s Treasury stake has more than doubled over
the course of
2012
to
23%
as of Dec.
31
. Meanwhile,
their overall corporate credit exposure (including
investment-grade and high-yield) has been reduced
from roughly neutral relative to the index to a
5
-percentage-point underweighting.
Fidelity’s investment-grade bond team has similarly
been cutting back on credit risk;
Fidelity Total Bond
FTBFX
typically holds a strategic allocation to high-
yield and emerging-markets bonds (currently
13%
combined), but its Treasury stake climbed to
28%
as
of March
31
,
2013
. Even the venturesome
PIMCO
Total Return
PTTRX
was getting roughly half its port-
folio’s duration from Treasuries of late.
Some bond-fund managers’ decisions to play it
relatively safe, even if it means shifting assets into a
sector that offers little to no long-term value at
current monetary-policy-elevated prices, should help
inform investors’ expectations for what kind of per-
formance they can expect from their bond funds. Even
emerging-markets bond and high-yield funds may
not offer the antidote to today’s low yields.
œ
Contact Miriam Sjoblom at
Bond Funds Bring It on Home
Income Strategist
|
Miriam Sjoblom
