In the third of a series of interviews fixed-income manager Dan Fuss gave to Morningstar in September this year, he follows up on his theory that interest rates are set for a long-term secular rise. In that framework, there are still some sectors along the credit spectrum offering value, although spreads have compressed a lot, he says. Corporates are not too bad an investment, he points out, but treasuries “seem to be priced higher than a kite.”
In previous interviews, Fuss discusses that Interest Rates Look Set for Long-Term Rise and that Nothing is Outlandishly Cheap on the fixed-income market.
Kathryn Young: As a bond fund investor how are you managing the transition from where we are now to when the rates will start that secular trend?
Daniel Fuss: Very carefully. You don’t want to read about it after the fact, so you have to adjust beforehand. Specifically in the case of Loomis Sayles Bond Fund, Strategic Income Managers Bond Fund and other situations like that, we've brought the average maturity in from the longest cases, something like manager's bond or investment grade bond, 19 years into 10 or 11 years, that’s a lot, that’s a great deal.
Now, with the mutual fund you can't go cutting the dividend, so you can't bring it in much more than that right now. That’s been the key move. Secondarily, you emphasise whatever the value is with that parameter. So, you want to start the adjustment before the event. So that you are there. Because bond market adjust very fast, it’s a dealer market, it's not an auction market, you don't need trades to do it.
Young: So what sectors then are offering the best value in that framework?
Fuss: Well, where it has been, has been along the credit spectrum. And I am using that term a little bit in the past tense right now, because the yield spreads have compressed a lot and have been very, in my mind, indiscriminate and because you've had an imbalance between money coming in and what was available to invest in, at the beginning, that’s starting to get into better balance, most noticeable in high yield emerging market debt, particularly emerging market local pay.
And with the advent of the ETFs really accelerated, not quite so bad an investment grade corporates. Treasury market for other reasons subjectively seems to be priced higher than a kite, it is just, but you have our own central bank buying all the way out till 30 years, and you have offshore with big money doing the same thing. So that supports that market, drives down those rates and other rates key off that.
Corporate side credit trends are very, very good for the moment. They are good in their earnings and balance sheet both. That will probably go on for a while, but not in the same order of magnitude, but issuers are now starting to perhaps borrow money they don’t need, because it is so cheap. I don’t blame them, I would too.
Young: So do you have any advice for all the mutual fund investors out there who are deciding what to do with their money and many of them are putting them into bond funds during this tough time of absolutely – yields that are low on absolute levels?
Fuss: Be careful. I can't help but be a bit self serving here. I run bond funds, but the glory days are over. You can make good returns with the lag in nominal terms – not inflation adjusted, in nominal terms, in a period of rising interest rates, again with a bit of lag, as long as you are reinvesting, you are reinvesting at a continually higher rates. If you are not reinvesting, you got a problem, but you need flexibility. If you tie yourself directly to just the base rate of interest, the only thing that will save you is the gradual reinvestment of those coupons and maturities, a Treasury ladder for example or a municipal bond ladder.
That's not a bad strategy, if you have no other options. Yet be careful with the mutual funds, because the mutual fund doesn't mature like an individual bond. That's alright. The mutual fund has many other advantages depending on its mandate. It doesn't depend so much on me as a manager, while I think it does, but it depends on the mandate of the fund and then how comfortable the manager is with that. And generally the key thing in the mandate is flexibility, to go to different areas of the market within reason, and that is more and more important in our globalised world.
Young: Okay. Stay flexible.
Fuss: Right.
Young: Well, thanks so much for being here with us. We really appreciate it.
Fuss: Thank you.
