Peter Palfrey: Bond strategy aims for capital preservation

There has probably never been a more challenging time to be a fixed-income manager. Rates are at, or near, all-time lows — making it harder than ever to find income. At the same time, the global economy is slowly healing from the wounds of the financial crisis, making it ever more likely that rates will begin to rise again. When rates rise, bond prices fall. That is why this year is all about capital preservation, said Peter Palfrey, 52, portfolio manager of the $1.7 billion Loomis Sayles Core Plus Bond Fund (NEFRX). He is probably not the first bond manager financial advisers think of when they hear the name Loomis Sayles & Co. LP. That honor belongs to legendary manager Dan Fuss. When it comes to capital preservation, however, Mr. Palfrey's fund is arguably the better choice. His fund, co-managed with Richard Raczkowski since 1999, was up 0.62% in 2008. Mr. Fuss' $22 billion Loomis Sayles Bond Fund (LSBRX) fell 22% that year. Thanks to missing out on that big drop in 2008, a $10,000 investment in the Core Plus Fund at the end of 2007 would be worth about $15,387 today. A similar investment in the Loomis Sayles Bond Fund would be worth $14,925. At the heart of Mr. Palfrey's strategy is the “plus” portion of the fund, which allows him to dial up the risk in the fund when it is worth it. The fund, which has at least 70% of its holdings benchmarked to the Barclays U.S. Aggregate Bond Index at all times, can invest up to 20% in high-yield bonds and 10% in non-U.S.-dollar bonds. “In down markets, we want to be as close to the benchmark as we can be,” Mr. Palfrey said. “In a stable or improving environment, we can go outside of the index and get some incremental return,” he said. “Over 10 years, we've added almost 300 basis points of performance that way.” The key to knowing when to turn up the risk is to understand what is driving the market, Mr. Palfrey said. “We spend a lot of time trying to determine what the rest of the market is thinking,” he said. Thinking was one of Mr. Palfrey's academic pursuits as a student at Colgate University. He double majored in philosophy, for fun, and economics because he knew he needed to get a job. Studying philosophy has helped Mr. Palfrey as a portfolio manager, though. And “there's a huge positive for studying economics,” he said. “It's about relationships and understanding what's driving the market.” Once you know the drivers, you can be ready to pounce on any mispriced movements, Mr. Palfrey said. Today the drivers are the central banks. “It's not just the [Federal Reserve],” Mr. Palfrey said. “It's the Bank of Japan, it's the Bank of England and the European Central Bank, too. All banks are artificially depressing yields,” Mr. Palfrey said. Now he is watching for signs that the banks will start letting rates rise. Until that happens, the portfolio is running near its maximum exposure to high-yield bonds.