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MUTUAL FUND | BG23
What top bond-fund managers are saying
Rising rates don't have to mean
despair for bond-fund in-
Yes, the Federal Reserve
raised short-term rates
Wednesday, the latest move
higher in what economists expect to be a long
campaign. Bond investors have historically
seen rising rates as the enemy because they
result in falling prices for the bonds they
High-profile bond fund managers are
urging their shareholders not to lose hope.
Expect lower returns than in earlier years
of the decades-long bull market, for sure,
but don't give up. Ford O'Neil of the Fidelity
Total Bond fund and Mary Ellen Stanek and
Warren Pierson of the Baird Core Plus Bond
fund were all nominees for this past year's
Morningstar fixed-income fund manager
of the year. (O'Neil's team won the prize.)
Here are some points they're making:
Bonds will stay in demand,
which should help keep a lid
Populations around the world are getting
older. As they move into retirement, just
like the Baby Boomers are doing, they'll be
looking for investments that provide income.
That should set a base level of demand for
bonds, regardless of how many times the
Federal Reserve pushes rates higher.
Plus, the world has been hungry for in-
come given how the Federal Reserve kept
short-term rates pinned at nearly zero for
years following the 2008 financial crisis.
That means many investors will pounce on
anything with a higher yield, Stanek says.
That demand from insurance companies,
pension funds and other investors looking
for income should also help limit the rise
Pierson says the yield on the 10-year
Treasury could climb as high as 3 percent this year,
up from its current 2.51 per cent, but he doesn't see
it going much above that.
There is an upside to rising rates
When rates rise, prices for older bonds fall, but
new bonds pay more in interest. As long as the rise
is gradual, the higher income can offset the price
declines for older bonds.
Bond-fund managers say they'll appreciate work-
ing in a market where prices and yields will again
be determined more by economic growth, inflation
and other traditional measures, rather than what the
Federal Reserve is doing.
"The Federal Reserve has moved from being referees
of the game to being participants on the field," O'Neil
says. "If we do get what we expect---modestly rising
interest rates---we're on the path to normalisation.
And that, to me, is a really good outcome."
All the potential change coming
out of Washington is dizzying
Not only are investors wondering about the pace of
rate increases from the Fed, they also have to contend
with the wide range of possibilities coming out of
Capitol Hill and the White House.
Republicans have talked about a tax cut, but they
haven't given many details. They've talked about re-
vamping trade deals, but investors don't know how
that will play out. An infrastructure plan could jolt
the economy. But, again, the details. Each of those
issues could have a big impact on the bond market,
but managers don't know which way they'll go.
"It's important to war-game and think about your
portfolio and all the risks," says O'Neil. "But it's im-
possible to set up your portfolio for one of a dozen
outcomes, because it's very hard to understand what
the probabilities look like for each of those potential
Control what you can
"The range of possible outcomes is so wide, so we
say: Control what you can control," Stanek says. For
regular investors, that includes keeping costs low by
investing in funds with low expense ratios. With re-
turns likely to be lower, keeping as much as possible
of it is key.
For Stanek, that means keeping her fund well di-
versified. She doesn't want to concentrate too much
on any one area of the bond market, whether that's
high-yield bonds or investment-grade corporate
bonds, when there's so much uncertainty about who
the winners and losers will be.
Her Baird Core Plus Bond fund can put up to 20
percent of its money in high-yield bonds. These, as
their name suggests, pay higher yields than invest-
ment-grade bonds, but they come with a higher risk
The Baird Core Plus Bond fund had only 8 percent
in high-yield at the start of the year, including about
2 per cent in high-yield corporate bonds.
Expect more volatility than in
prior years, and lower returns
With yields low, bonds are producing relatively
small amounts of income. And with rates likely ris-
ing, their prices are more likely to go down than up.
The other thing that bond investors worry about
most, inflation, could be another risk. It's been nudg-
ing up, and an unexpected rip higher would pummel
The smooth ride bond funds provided for many
years is also likely over. With the Fed finally back in
the mode of raising rates, bond investors are con-
stantly pricing in---and out---their expectations for
upcoming hikes, and bond prices move up and down
"We probably are in a rising-rate environment,"
Pierson says, "but very rarely do you see rates just
go up continuously."
AP's Stan Choe
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