Pimco Unconstrained Bond Fund (PUBAX) and other “go-anywhere” bond funds created during the 2008 credit crisis went mostly to the wrong places in 2011 after missing a rally in Treasuries and buying riskier assets that lost ground.
Funds that Morningstar Inc. calls “non-traditional” declined an average of 1.8 percent this year through Dec. 5 while the Barclays Capital U.S. Aggregate Bond Index gained 7 percent, the Chicago-based research firm said. The $15.5 billion Pimco Unconstrained Bond Fund, the biggest such fund, has lost 0.1 percent this year and the $13.5 billion JP Morgan Strategic Income Opportunities Fund, the second-biggest, fell 0.5 percent.
Pacific Investment Management Co., JPMorgan Chase & Co. (JPM) and rival firms have collectively amassed more than $50 billion since 2009 in such funds, attracting investors with the promise of bond selection unconstrained by maturities, credit quality or region, and the ability to protect against rising interest rates. This year, Europe's debt crisis drove investors worldwide to the safety of U.S. Treasuries, pushing down interest rates and hurting managers who expected rates to climb.
“Sometimes the future takes a turn that is surprising to even the smartest among us,” Jeff Tjornehoj, an analyst with Denver-based Lipper, said in a telephone interview. “Investing in Treasuries wasn't how these guys expected to make a living.”
'Dangerous' Treasuries
William Eigen, who runs the JP Morgan fund, said that while he is disappointed with his “flat” performance this year, he isn't unhappy with the choices he made.
“I don't regret not owning Treasuries because they were dangerous,” Eigen, who has managed the JP Morgan Strategic Income Opportunities Fund (JSOAX) since its inception in 2008, said in a telephone interview from Boston. “In fixed income you need to be looking at alternatives.”
So-called “go-anywhere” bond funds were created during the 2007-2008 financial crisis, spurred by the decline in interest rates to near zero and a widespread belief that an inevitable increase in rates would hurt traditional funds, said Eric Jacobson, Morningstar's director of fixed-income research. Bond prices fall as interest rates climb.
“There was a fear that even good funds would get whacked at some point,” Jacobson said in a telephone interview.
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The premise helped the non-traditional funds attract $9.2 billion in 2009, $27.6 billion in 2010 and $13.7 billion in the first seven months of this year, according to Morningstar. In 2010, Eigen's fund, Pimco Unconstrained and the $6.5 billion Eaton Vance Global Macro Absolute Return Fund (EIGMX) were among the 10- best selling bond funds in the U.S., Morningstar data show.
By the end of October, the non-traditional funds had $55 billion in assets, up from $2.8 billion at the end of 2008. Investors pulled almost $4 billion from non-traditional bond funds in the three months ended Oct. 31, after performance this year trailed the bond market.
If rates rise or even level off in 2012, bond funds with more flexibility should have an edge, said Greg Lavine, who owns Eigen's fund.
“We aren't in love with the performance lately, but funds like this have a purpose,” said Lavine, an adviser with Altfest Personal Wealth Management in New York, which manages $800 million.
The flexible funds can buy a wide range of fixed-income assets both in the U.S. and around the world and, like hedge funds, they have the freedom to short securities. The funds returned an average of 19 percent in 2009, as riskier assets such as junk bonds and emerging market bonds rallied, said Jacobson. They gained 5.1 percent in 2010, compared with 6.5 percent for the Barclays Aggregate.
This year the funds didn't participate in the Treasury rally. Treasuries returned 8.9 percent through Dec. 5, according to the Bank of America Merrill Lynch U.S. Treasury Master Index.
Pimco Unconstrained
In an August interview posted on Pimco's website, Chris Dialynas, manager of Pimco Unconstrained, said his fund was positioned to offer “marginal exposure to overall interest-rate risk.” The Pimco Unconstrained Fund can have a duration of as low as minus three years, meaning the fund can benefit if interest rates rise. The fund's duration was 2.5 years at the end of October.
Duration measures a bond's sensitivity to changes in rates.
The non-traditional funds have an average duration of about 1 year, compared with 5 years for the Barclays Aggregate Index, according to Morningstar. Treasuries represent 35 percent of the index, according to Vanguard Group Inc.
Pimco Unconstrained had 32 percent of its assets in mortgages, 21 percent in investment grade credit and 28 percent in emerging markets at the end of October, according to information posted on Newport Beach, California-based Pimco's website. The fund had 21 percent in Treasuries, which was more than offset by hedges in the swap and futures markets.
Emerging-Market Bonds
Dialynas, who declined to comment for this story, has said this year that he likes Asian currencies, bonds in selected emerging markets and mortgages, while avoiding Europe. The fund fell 0.1 percent through Dec. 5.
While losing out on the rally in Treasuries, investments the group of funds made in markets such as junk bonds and emerging market currencies haven't worked out as well.
High-yield bonds, 33 percent of Eigen's portfolio at the end of October, returned 3.1 percent this year through Dec. 5, according to the Bank of America Merrill Lynch U.S. High Yield Master II Index.
The managers of Pimco Unconstrained and Eaton Vance Global Macro said in their third-quarter reports that declines in some currencies, including the Mexican peso, hurt performance. The peso fell 16 percent against the U.S. dollar in the quarter, Bloomberg data show.
‘Speed Bump'
Michael Cirami, a co-manager of Eaton Vance Global Macro, said he is convinced his fund's holdings in emerging market bonds and currencies will pay off. Emerging market economies have better growth prospects and stronger finances than economies in the developed world, which are plagued by heavy debt burdens, he said.
“We view 2011 as a speed bump in a trend that will continue for a number of years,” Cirami, 35, said in an interview in the firm's Boston's office.
Cirami, who joined Eaton Vance in 2003, has worked on the fund since 2008. The fund, down 0.1 percent this year, had 60 percent of its assets in foreign sovereign bonds and 8.2 percent in Treasuries at the end of the third quarter.
In retrospect, said Cirami, while it would have been nice to own more Treasuries, the risk-reward trade-off on the investment was unattractive.
Favoring Junk Bonds
“We like to have a position where we can lose a little and make a lot,” he said. “Treasuries were the exact opposite of that trade.”
Forecasters surveyed by Bloomberg expect the yield on the 10-year Treasury note to reach 2.73 percent in the fourth quarter of 2012, up from 2.08 percent as of Dec. 6.
Eigen favors junk bonds because their yields imply too gloomy a view of the economy and potential default rates. Using the same logic, he is selling protection on distressed companies, betting that the market is overly fearful of defaults over the next 18 months.
“Our economy is healing, not getting worse,” he said.
High yield, high-risk debt is likely to return 13.6 percent in 2012 as corporate balance sheets are in “pristine shape” and defaults stay low, according to a report by New York-based Morgan Stanley.
The jobless rate in the U.S. fell to 8.6 percent in November, the lowest since March 2009. Car sales for the month were the best since August 2009.
Short Treasuries
Eigen said he will continue to avoid Treasuries because they are yielding less than the rate of inflation. The yield on the five-year U.S. Treasury note is below 1 percent, according to data compiled Bloomberg. Consumer prices rose 3.5 percent in the 12 months ended Oct. 31.
“I would own Treasuries if I were getting paid to own them,” Eigen said. “At these levels it makes no sense.” The fund currently has a “slight” short position in Treasuries, he said.
Eigen, 43, spent 12 years as a bond manager at Fidelity Investments in Boston, before joining JP Morgan's hedge fund operation, Highbridge Capital Management, in 2005.
The ‘go anywhere' funds got popular because they promised protection in the event of rising interest rates, said Morningstar's Jacobson.
“The managers avoided rate risk, but they took on credit risk by buying foreign bonds and high yield bonds,” said Jacobson. “It just illustrates that there is no free lunch.”
--Bloomberg News--
