What Some Smart Bond-Fund Managers Are Betting On Now

While interest rates are expected to rise in the US, some high-profile mutual-fund managers differ on their investment strategy. Four major investors share their approach with the Wall Street Journal.

Source: Wall Street Journal

As markets look for the Federal Reserve to raise rates three or even four times this year, star bond managers have embraced different strategies. Much of their differences boil down to a simple question: Do they share the economic optimism that fuelled the so-called Trump Bump (the surge of market enthusiasm that followed Donald Trump’s election win) or not?

For every manager like Loomis Sayles’s Dan Fuss, betting on corporate bonds, believing defaults will be rare in a strong economy, another is adding less-glamorous mortgage securities that allow for more weakness. Pros like Bryan Whalen, co-manager of MetWest Total Return (MWTIX), say the corporate-bond rally is overdone despite a recent downtick, and post election optimism is, too.

“We have felt that earnings growth, real economic growth, real income growth, have been insufficient to support the debt load that has built up,” Mr. Whalen says. “You can ignore fundamentals for a long time, but not forever.”

We talked to major investors about how they’re approaching the bond market, and why. Here are some highlights.

Elaine Stokes, Loomis Sayles Bond

The managers of the $14 billion Loomis Sayles Bond Fund (LSBRX) think the economy is healthy enough to take some credit risk on bonds to boost returns.

To a degree, that has meant acting and thinking something like stock pickers—not surprising, since nearly a quarter of the fund is in high-yield (or junk-rated) debt, an investment that requires detailed knowledge of company fundamentals and an appreciation of how sentiment can move short-term values.

Co-manager Ms. Stokes and her partners—Mr. Fuss, Matt Eagan and Brian Kennedy —also are weeding out bonds from challenged industries such as retailing in favor of financial-company bonds, which have been bolstered by stiffer capital requirements so unpopular in Washington.

One note of caution: Citing “political risk,” Mr. Fuss said in March that the fund is focusing on shorter-term bonds, a shift Loomis says is mostly within its government-bond holdings. The fund is still adding corporate bonds, confident that credit conditions are solid, Ms. Stokes say.

Scott Mather, Pimco Total Return

Pimco’s $74 billion Pimco Total Return fund (PTTAX) is now run by three managers, including Mr. Mather, and pretty conservatively. Only 19% is in corporate credit, and only 3% represents high-yield debt. Instead, the fund’s holdings are concentrated in government-related securities and mortgage-related paper, categories that overlap because of Washington’s role in mortgage-bond markets.

To Mr. Mather, this is a logical reaction to the 9% run-up in corporate debt prices in the first half of 2016, and it has paid off modestly: Total Return is beating its benchmark with a 3.16% gain this year through May, after trailing in 2014 and basically matching it for the 2013-15 period overall, according to Morningstar data. Within corporates, Pimco favors conservative plays such as insurance firms, as well as mortgage bonds in both residential and commercial sectors, except for debt from real estate built for retailers, which are losing customers to online rivals. The managers also are skeptical of developed-market non-U.S. corporate debt.

Michael Collins and Robert Tipp, Prudential Total Return

Like Loomis Sayles, Prudential’s $24 billion Prudential Total Return Bond fund (PDBAX) is heavy on corporates and light on Treasurys: The 8% of its assets in Treasurys is a fraction of their weight in the benchmark index. The fund is overweight (relative to its benchmark) in corporate debt, including high-yield, emerging-markets bonds and asset-backed securities.

Prudential feels good about credit risk, and it will add risk to get yield, says Mr. Collins, senior investment officer at Prudential. But it isn’t infinite: The fund, which is up 3.75% this year through May, has pared junk holdings by a third, a move Mr. Collins mostly chalks up to profit-taking after the rally in corporate bond prices over the past year.

Rick Rieder, BlackRock Inc.

Few oversee more bond assets than Mr. Rieder, chief investment officer for global fixed income at the world’s largest asset manager. He says he is using hedging instruments and global diversification to avoid too heavy a macro bet in either direction—but BlackRock is betting that paper with maturities of two to five years will outperform short-term Treasurys as rates rise.

BlackRock has added inflation-protected Treasurys to lower the interest-rate sensitivity of its $1.6 trillion portfolio, including the flagship $28 billion BlackRock Strategic Income Opportunities (BASIX) fund, which is up 2.02% this year through May. It also is reducing exposure to principal losses from rising U.S. rates by adding debt from countries where interest rates are still falling.