Top rated bonds “just don’t make sense,” says veteran Dan Fuss. Buy them instead.
The putative ‘bond kings’ have only reigned during the bull markets of the past four decades or so, periods in which yields have fallen steadily, meaning that bond prices have risen, if not every month, at a rate. persistent over time.
But Dan Fuss, 88, remembers a time when the trend was definitely not favoring fixed income investors. “I’m going back to 58,” Loomis Sayles vice president said in a phone conversation last week. And although he moved away from day-to-day portfolio management over the past year, he continues to provide advice and guidance to Loomis staff.
Fuss arrived at about a third of the post-WWII bear market, which saw long-term government yields drop 2Â½%, where the Federal Reserve had earmarked them to help fund the war effort. , at a peak of 15%. % by September 1981. A 30-year 2.5% constant maturity bond would have lost 83% of its value during this period, using the conventional method A history of interest rates, by Sidney Homer and Richard Sylla.
But to make investment decisions now, he says, he wouldn’t rely on the history of the 1970s and 1980s, when inflation and interest rates hit double-digit records. Back then, cutting large interest coupons and reinvesting them at ever higher rates helped offset the ravages of the bear market. Even during the sad decade of the 1970s, $ 726 invested in Baa-rated corporate bonds would have risen to $ 1,153, according to data from the NYU Stern School of Business. (The series started with $ 100 invested in different asset classes, starting in 1928.)
Now, with paltry yields of around 1.75% on 10-year T-bills and with triple-B companies providing only about a percentage point more, there is very little interest income to amortize the bonds. price cuts. âIt makes no sense to buy good corporate loans at current yields,â says Fuss, arguing that highly profitable companies with strong balance sheets act in the best interests of equity investors, not their creditors.
For example, he continues, some leading pharmaceutical manufacturers have a habit of increasing their dividends by 5-10% per year. Even assuming their stocks aren’t going up in the long run, these increasing payouts would mean that an investor in stocks would likely earn at least twice as much, and possibly four times as much, as the owner of the company’s bonds.
Instead, Fuss would go for a BB credit set, the top rung of what’s still called high yield and with the potential to be promoted to investment grade. He cites the debt of
(ticker: F) and its credit subsidiary as examples. While the automaker’s bonds remain rated below the investment grade, its shares have more than doubled over the past year, bolstered by both the potential of its F-150 Lightning electric pickup and the strengthening of its balance sheet. Other speculative quality credits took advantage of favorable market conditions to refinance high-cost debt and extend maturities, he adds.
But rather than being bought on the basis of careful research and strict selectivity, most bonds today are traded in blocks of 30-40 credits for index-linked exchange-traded funds. Or they can be acquired by active managers who must consider a benchmark that they cannot risk falling too far behind. Ideally, these managers would do better if they had stable assets and the flexibility to deviate from their benchmark, luxury products that don’t offer open-ended funds, such as
Loomis Sayles Bond
(LSBRX), which Fuss led until last year.
The current yields, still historically low, reflect the massive liquidity provided by the Fed and other central banks. âIt’s not like any previous market I’ve even read about,â observes Fuss.
He compares the market to a frozen pond in March. When the ice gets smoother and smoother, it might melt and it’s time to get back to dry land. Extending the metaphor, he worries about a catastrophic event, comparable to the rupture of a large piece of glacier, which happened during the crisis induced by the pandemic of the markets in March 2020.
Markets already seem to fear the ice will be thinner by the time of global warming this year. They shuddered last week at the prospect of a Fed rate hike and reduction in its balance sheet sooner than consensus apparently expected, even though the central bank is still keeping its key rate close to zero and continues to increase its bond holdings.
Investors may nostalgically view the 1950s and 1960s as a quiet time for the markets, but Fuss says there were a lot of rock slabs around this time. Looking ahead, there are longer-term risks of climate change, geopolitical disruption, and the dollar’s loss of purchasing power. The reigns of ancient bond kings are already looking like the good old days.
Write to Randall W. Forsyth at [email protected]