Legendary bond investor Dan Fuss is practically giddy about the potential of rising interest rates because it means higher payouts for investors, but he isn't excited about the moves that some investors are making to dodge the short-term losses that come with higher rates.
Since interest rates began to rise in May, investors have pulled out about $63 billion from core bond funds and put $26 billion into nontraditional bond funds that have the ability to go short.
“Does that worry me? You betcha,” Mr. Fuss said. “You have to be very, very careful in long/short bond strategies.”
The allure of having the ability to short bonds is easy to see, if, like Mr. Fuss, one is of the opinion that rates are more likely to rise than fall. Because bond prices and interest rates move inversely, shorting gives a manager the ability to benefit from the falling bond prices.
Having the ability to do something and actually being able to do it successfully again and again are two different things, though.
“I understand the reasoning,” Mr. Fuss said. “I just think the odds of success are very low.”
What makes shorting bonds particularly difficult is that time is always against you, Mr. Fuss said.
When shorting a bond, an investor has to make the coupon payments that are tied to the bond. So if the call isn't executed quickly, the losses could be worse because of the negative carry.
Investors got a glimpse of just how hard it is to pull off a long/short bond strategy in June when rates rose to 2.53% on the 10-year Treasury, from 2.13%.
The average nontraditional bond fund lost 1.63% during the month, according to Morningstar Inc.
Classic bond funds fell 2.6%.
Loomis Sayles & Co., where Mr. Fuss oversees fixed income, is among the many firms that have launched nontraditional bond funds.
The team that runs the $1.3 billion Loomis Sayles Strategic Alpha Fund (LABAX) all sit within 35 feet of Mr. Fuss' corner office at the company's Boston headquarters.
“I'm the skeptic,” he said.
Mr. Fuss joked that he acts like a policeman for the fund at times.
Really, no bond fund could ask for a better one.
Mr. Fuss, who turned 80 today, is the manager of the two best-performing bond fundsover the past 10 years, according to Bloomberg data.
The $15.1 billion Natixis Loomis Sayles Strategic Income Fund and the $21.7 billion Loomis Sayles Bond Fund (LSBRX) both returned more than 125% over the period, ranking first and second among 65 bond funds with more than $5 billion in assets that have been in existence for at least 10 years.
Still, Loomis' nontraditional bond fund hasn't been able to keep pace with Mr. Fuss' flagship bond fund.
This year the Loomis Sales Strategic Alpha Fund lost 0.73% through Sept. 26. Mr. Fuss' Loomis Sales Bond Fund, which can invest across a wide range of fixed-income instruments but doesn't short, returned 3.21%.
So maybe it is better to stick with the classic.