Bonds’ rally surprises many
Even the most respected mind in the bond world is going into the new year with a good dose of humility.
Bill Gross, Pimco’s famed bond guru, made a big public bet last year that U.S. Treasury bonds would fall in value. When the opposite happened, 2011 saw customers flow out of Pimco’s flagship bond fund for the first time ever, according to data firm Lipper Inc.
Gross apologized to customers. And in a letter written last week, he reversed course and called Treasuries a smart investment for 2012.
He wasn’t the only famous market watcher who misread the bond market last year. Financial analyst Meredith Whitney -- famous for her early warnings of the mortgage meltdown -- began 2011 by warning of a meltdown in municipal bonds. Instead they ended up being one of the best investments of any class.
“It was a confusing year on anything related to fixed income,” said Kurt Brouwer of the mutual fund consulting firm Brouwer & Janachowski. “A lot of people had a hard time last year.”
Whitney and Gross both stumbled by predicting that bonds would become less attractive investments in a world of low interest rates and big national debts. But with the turmoil caused by the European financial crisis, the relative safety of bonds drew investors.
Americans poured a net $131 billion into taxable bond mutual funds through November, according to data from the Investment Company Institute. By contrast, a net $115 billion flowed out of U.S. stock mutual funds.
In a twist on investing logic, it turned out that some of the safest investments provided the biggest returns. Mutual funds specializing in long-term U.S. government bonds returned, on average, 32.8% last year, according to Morningstar Inc. A more general bond fund, reflecting the entire U.S. bond market, returned 7.8% in a year when the benchmark stock index, the S&P; 500, returned just 2.1%, including dividends.
Given the continuing uncertainty in Europe -- and the unprecedented crosscurrents roiling the bond markets -- industry experts are being unusually careful about making any big predictions for the coming year.
“Anybody who is in the bond world has to be very careful. It’s not easy to see where things are going,” Brouwer said. “It’s very hard for anyone today to do anything other than be very diversified.”
Generally bond investors make their decisions by watching interest rates. When rates fall, the value of current bond holdings goes up, making bond funds an attractive investment. The Federal Reserve has publicly said it wants to hold interest rates down until at least mid-2013. But with rates already near historic lows, there are questions about whether they can go down any more.
“Interest rates may not rise, but they aren’t going to go a whole heck of a lot lower,” said Geoff Bobroff, who runs his own mutual fund consulting firm.
Bobroff doubts that bond mutual funds will show the same strong returns as last year, but he is still loading up on them because they offer a safety he sees nowhere in the stock world.
Because of the lower returns that he is expecting, Bobroff is focusing more on index funds, which have fewer of the management costs that eat away at a customer’s returns.
Gross blundered last year by predicting that interest rates would not go any lower for U.S. Treasury bonds. He was proved wrong when the European debt crisis revived fears of another financial crisis, driving investors to take the low interest rate on Treasury bonds in exchange for their safety.
In his letter to clients this week, Gross said he and other investors are becoming like Will Rogers, who joked during the Great Depression that “he was more concerned about the return of his money than the return on his money.”
Jeff Tjornehoj, a bond analyst at Lipper, said he was expecting to see similar movement from stocks to bonds in the coming year.
“The fear of Europe hasn’t abated,” Tjornehoj said. “To the extent that keeps people uncertain about the future, it bodes well for fixed income.”
After Gross’ public apology for last year, investors appear to be largely standing by him. Although Newport Beach-based Pimco’s flagship Total Return Fund had a net outflow of $5 billion for the year, according to Morningstar, it still holds $244 billion. More important, Pimco’s mutual funds as a whole -- most of which are bond funds -- gained more customer money than any other management company: a cool $38 billion, according to Lipper.
But it was another Southern California firm specializing in bond funds that made an even bigger splash with investors. Jeffrey Gundlach, who started DoubleLine Capital after a messy divorce from TCW Group Inc., quadrupled the amount of money under management in only the second year of his L.A. company. His core fixed-income fund returned 11.5% in a category where the average fund rose 7.4%, Lipper data show.
The bond fund category that most investors use focuses on intermediate-term investment grade bonds. It was telling that the best-performing fund in this group was a passively managed index fund from Vanguard, not a fund run by an easily confused human.
