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Talking Points: No Clarity on Bonds

What Morningstar analysts are hearing about the bond market.

Morningstar, 04/06/2012

This article originally appeared in the April/May 2012 issue of MorningstarAdvisor magazine.  To subscribe, please call 1-800-384-4000.

The Issues
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 Points

  • 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).


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