Seven Pillars of Wisdom for Bond Buyers from Dan Fuss

Seven Pillars of Wisdom for Bond Buyers from Dan Fuss

There are no totally safe places in the bond market. The threat of capital loss is nominal if you invest in short-term Treasuries, but you have supreme reinvestment risk.

Dan Fuss, Loomis, Sayles & Company The Loomis Sayles Bond Fund has returned more than 10 percent a year over the past 20-plus years—about 3 full percentage points beyond the return for the entire bond world all through this same period. At the helm of the fund since 1991 sits Dan Fuss, who is also vice chairman of the Boston-based Loomis, Sayles & Company. He has been handling investments for more than half a century. Dan Fuss was honored March 8 2012, as the beneficiary of The Lipper Award for Excellence in Fund Management at Lipper’s annual mutual fund awards ceremony in New York City. According to Jeff Tjornehoj, head of research for Lipper Americas, the Award for Excellence in Fund Management, “recognizes an outstanding asset manager who has delivered consistently strong risk-adjusted returns to their investors and, in the opinion of Lipper’s research analysts, represent the best of the funds industry.”

  • Don’t trade. Even institutional buyers get killed by bid-ask spreads. Only exception: coupon Treasurys.
  • Avoid junk. Especially the covenant-lite stuff that is coming out now.
  • Buy TIPS direct. If you must own inflation-protected bonds (yields are meager,) but at a Treasury auction to avoid the nasty spreads. Inflation insurance in the form of TIPS, or Treasury Inflation Protected Securities, has returned about 10% this year, according to Barclays Capital indexes.
  • Stay in North America. Japanese and European yields are ridiculous.
  • Beware ETFs. The liquidity of exchange-traded funds will evaporate in a crash if they own junk or emerging market bonds.
  • Hold some cash. Put it aside to use in the next financial crisis.
  • Look for discounts. A corporate bond trading at 90 cents on the dollar won’t be called away in the rebound.

As you head to work in the morning and look around you, you get a sense for what season it is. Just as the calendar has seasons, there are also seasons of the economy, what one can also refer to as “cycles.” These can greatly affect bond returns. One advantage I have is being older than the hills . . . I’ve seen a good number of seasons, and I can perhaps recognize them a little better or quicker than most.

Market Unpredictability in Bond Markets

Bond markets in many ways are like other financial markets, where market unpredictability can play an imperative role in determining whether an investment will be moneymaking. The main source of volatility in the bond market is a variable interest rate since this affects the coupon on the bond, which is where the profit is made. If an investor bought a bond with a fixed coupon rate, changes in the interest rate will not affect the bond. However, if the coupon rate is associated to a variable interest rate and that rate changes, it may be advantageous for the bondholder to sell the bond rather than keep it until the maturity date. Traders, institutions, and other actors in the bond market implement transactions like this every day; the sum of these actions is what makes up the bond market.

A significant theory of finance is that the evaluation of returns is only meaningful on a risk-adjusted basis. However, risk is often hard to measure. This creates a chief restriction in the delegation of investment decisions. Financial go-betweens and investment managers that are evaluated based on deficient risk metrics face an inducement to buy assets that comply with a set yardstick but are risky on other dimensions.

But since individual voters cannot change election outcomes, they will not carefully weigh benefits and costs of default. Instead, they will place massive weight on symbolism and status-group affiliation—they will allow their feelings to abuse the facts of the matter. It is quite unlikely that defaulting nations will be considered high-status, so voters will be reluctant to support politicians who support default. Politicians who support default will likely find themselves turned out of office, a fact that foresighted politicians will keep in mind.

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