It takes an iron-clad constitution to navigate the fixed-income markets these days. No wonder Dan Fuss, manager of the $18.5 billion Loomis Sayles Bond Fund (LSBRX), orders a plate of spinach for lunch on a mid-October afternoon.
Among fixed-income investors, Fuss has shown Popeye-like strength over the years. He doesn't have the name recognition enjoyed by Pimco chief Bill Gross, manager of the massive Pimco Total Return Fund, now the nation's largest mutual fund with $186 billion in assets. But Fuss, 76, has a leg up on his competitors—after all, he's been managing money for five decades.
Discussing the events of the financial crisis during a meal at a restaurant literally in the shadow of Lehman Brothers' former headquarters, Fuss says: "It wasn't pleasant to go through." Indeed, the Loomis Sayles Bond Fund lost 22.1% in 2008. Fuss likens investing in the bond market's choppy waters to the day he crossed the Atlantic in a Nor'easter, when he was a Naval midshipman. "I made a mental note to myself: 'Avoid Nor'easters,'" Fuss says.
For Fuss, the biggest lesson from the past year is to keep the portfolio, which he co-manages with Kathleen Gaffney, as liquid as possible. The bonds he worried most about when the credit crisis hit were offerings from sovereign issuers, such as Mexico, Canada, and New South Wales. What surprised Fuss the most is that those and other foreign governments supported their bond markets to avoid a credit crunch. What Fuss did not anticipate is that giant corporations such as Johnson & Johnson (JNJ) and Procter & Gamble (PG) would see their access to capital freeze up.
Avoiding Treasuries Today, the Loomis Sayles Bond Fund has about 12% invested in Canadian government bonds and 3% in Mexican debt. Yet its exposure to U.S. Treasuries, arguably the most liquid debt instrument in the world, is nil. That's because yields for U.S. Treasuries hover around the lowest levels in decades. And the one thing bond investors expect from the Loomis Sayles Bond Fund is yield—the portfolio is currently yielding about 6%. To generate that yield, one-quarter of the portfolio is invested in speculative-grade debt, although Fuss is reluctant to talk about specific bond credits.
Fuss also likes corporate bonds—some of the fund's top 10 holdings include issues from Intel Corp. (INTC), Medco Health Solutions (MHS), and International Paper (IP). Overall, corporate balance sheets look pretty good because corporations rushed to borrow debt when the window opened to capitalize on short-term interest rates, he says. Fuss muses that about half of the companies that came to market did so just because they could—which means they have extra cash on hand to grow their businesses or invest in technology upgrades. The big challenge—and one that is a huge hurdle for the health of the U.S. economy—is to coax them to do so.
In addition, Fuss is a big fan of bonds with BBB credit ratings which straddle the weird terrain of investment-grade debt and junk.
There are no screaming buys for bond investors, though. "The market is fairly valued," he says. Yield spreads, the difference between the yields of corporate debt and risk-free Treasuries, are about the same as they were 18 months ago, before the credit crisis hit, he notes. And while inflation isn't a worry yet, Fuss does expect inflationary pressures to reemerge … eventually. The problem is that he doesn't know when it will happen. As a result, he has pared the average maturity of debt issues held in the fund from nearly 14 years to 11 years to shorten its exposure to interest-rate risk.
Wrapping Up a Strong Decade As for the New Normal—the idea that the economy is resetting to a long period of slow growth—Fuss says: "I don't know what normal is anymore."
What is normal for investors is stellar long-term performance of the Loomis Sayles Bond Fund—it's gained an annualized 8.5% in the past decade, making it one of the best-performing multisector bond funds, according to fund tracker Morningstar (MORN). So far in 2009, it's up 32.63%. "Loomis Sayles Total Return takes an equity-like approach and, lately, has generated better than equity-like returns," says Russ Kinnel, director of research at Morningstar. Fuss "is an outstanding, wide-ranging investor," Kinnel says. In fact, Morningstar likes the Loomis Sayles Bond Fund so much that the firm added it as an option to their employee retirement plan about a month ago.
Aside from the fund's rocky period, the biggest bummer for Fuss is the fact that his beloved Boston Red Sox failed to make it through the American League playoffs. "It's too late to worry about the Red Sox now. It's already happened," he says. Still, his team should be a contender for years to come. Like Fuss, they appear to have found the key ingredient for long-term success. Maybe it's spinach.
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