Fixed-income investors should start bracing for inflation and rising interest rates, according to Thomas Atteberry, manager of the $3.7 billion FPA New Income Fund Ticker:(FPNIX).
“Inflation is returning, and as a bond investor that's the worst thing that can happen,” he said.
Mr. Atteberry manages the fixed-income fund at First Pacific Advisors LLC, a $15 billion asset management firm, $5 billion of which is in fixed income.
One telltale sign of inflation on the horizon, he explained, is the unusually wide spread (300 basis points) between the two-year U.S. Treasury bond and the 10-year Treasury, which is yielding 3.4%.
The 10-year Treasury was yielding 2.2% as recently as November.
“That's a steep yield curve, and steep yield curves usually precede increases in interest rates,” Mr. Atteberry said. “That [steep yield curve] tells you investors are fearful about inflation, because they are demanding higher yields to tie up their money for a longer term.”
For fixed-income investors, rising interest rates on new bonds means the ones they already own will decline in value.
“Right now, it seems like there's more risk in the bond market, but there isn't a lot more return,” Mr. Atteberry said.
The FPA New Income Fund is designed to be a relatively conservative means of generating absolute returns, regardless of market conditions.
Following that mandate, the fund has never had a negative year since it was launched in July 1984.
An example of how Mr. Atteberry has navigated the uncertain fixed-income environment: During the fourth quarter of last year, the fund barely eked out a positive return. Still, it wildly outperformed the major bond indexes.
The fund's fourth quarter gain of 0.4%, compared with a 1.3% decline by the Barclays Aggregate Bond Index and a 2.2% decline by the Barclays Government Credit Index.
Mr. Atteberry acknowledged that the conservative strategy has made the fund a safe haven at various times over the past few years, but cautioned that the fund should not be confused with a money market fund.
“We're constantly tying to identify risk, and then we look at whether we're being paid to take that risk,” he said.
The fund has broad flexibility with regard to bond duration and sectors, but it is limited to no more than a 25% allocation to non-dollar-denominated bonds, and a 25% allocation to bonds rated single-A or lower.
The portfolio's largest allocation, at 55%, is to securitized investments, including asset-backed securities, mortgage-backed securities and commercial-mortgage-backed securities.
Treasury and government agency bonds make up a little less than a third of the portfolio. And corporate bonds represent more than 11% of the fund.
Across the diverse portfolio, the average maturity of the underlying positions is 2.9 years, and the average duration of those securities is 1.4 years, suggesting a more cautious approach to the current market conditions.
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