What Morningstar analysts are hearing about the bond market.
This article originally appeared in the April/May 2012 issue of MorningstarAdvisor magazine. To subscribe, please call 1-800-384-4000.
The market confounded bond bears’ predictions
in 2011. By year-end, the 30-year U.S. Treasury
led all other bond sectors with a 35% gain.
Meanwhile, areas perceived as less interestrate-
sensitive—including high-yield corporates,
floating-rate bank loans, and local currency
emerging-markets debt—produced low-singledigit
returns to single-digit losses.
The market is still caught in a tug-of-war
between central banks’ reflationary efforts and
macro deflationary forces, a sentiment many
diversified bond managers have echoed in their
2012 outlooks. There’s less agreement, however,
about how to prepare for 2012. For instance,
Bill Gross and BlackRock’s Rick Rieder
took opposite sides of the duration debate
in early 2011 (for and against, respectively), and
they’ve now reversed their positions.
Bond managers’ ability to get 2012 exactly right
won’t determine whether a fund makes a good
long-term investment. It’s more important
to understand how and to what extent a fund
may be mining less-traditional areas, both to
ensure that it’s filling the right role in a
portfolio and to give investors the fortitude to
stick with it during what could be a bumpy year.
- The U.S. government debt-laden Barclays
Capital U.S. Aggregate Bond Index proved a formidable foe; more than 85% of the intermediate-term
bond category failed to keep up with its 7.8% gain last year. The third quarter marked the worst
relative showing on
record for Bill Gross’ PIMCO Total Return PTTRX; it lagged the Barclays Capital U.S. Aggregate Bond
Index by 488 basis points.
- While many managers acknowledge today’s uncertainty, they also seem to agree
that the Aggregate Bond index, despite its 2011 triumph, won’t hold the key to success
in 2012 and beyond. They point to its minuscule
2.2% yield (its lowest ever), 2011’s 3.0% increase in the consumer price index, and unprecedented
levels of central bank
easing here and elsewhere in the developed world to argue we’re entering a prolonged phase of financial repression in which
high-quality bonds will struggle to keep pace with inflation.
- Many now argue in favor of one or more out-of-index bets in areas, such as high
yield (Fidelity Total Bond FTBFX), convertibles (Loomis Sayles Bond LSBRX), “cleanest dirty
shirt” sovereign debt (PIMCO Total Return PTTRX), nonagency residential mortgage bonds and mortgage
derivatives (DoubleLine Total Return DBLTX), emerging-markets currencies (Templeton Global Bond
TPINX), and munis (just about everyone).
- Some managers who kept their funds’ durations low in 2011 see no reason to capitulate now
that bond yields have dropped even further (Dodge & Cox Income DODIX, Metropolitan West Total
Return Bond MWTRX).