Bond heavyweights take opposing Treasury views

Two heavyweight bond fund managers are squaring off in a battle over Treasuries.

On one side, Bill Gross, managing director and co-chief investment officer of Pacific Investment Management Co. LLC, has a 35% allocation to U.S. government bonds in his flagship fund, while Dan Fuss, vice chairman of Loomis Sayles & Co. LP, doesn't own any.

Both are betting that their way is going to lead to the best returns over the rest of this year and into the future.

Despite record low yields, Treasury bonds have been in the spotlight for the past two years — thanks, in large part, to the “risk on, risk off” trade that has become the norm. Also, the dollar's standing as the go-to reserve currency has made Treasuries a rallying point for investors whenever things get hairy.

Last year, the “risk-off” trade propelled long-term-government- bond funds to an average return of nearly 30%, higher than any other fund category, according to Morningstar Inc. Intermediate-term-government-bond funds didn't fare as well, but they did post an average return of 6.7%, compared with 2% for the S&P 500.

30-YEAR YIELD

The rally has caused what were nearly record-low rates for long- and intermediate-term Treasuries to plunge even lower. The yield for 30-year Treasuries now stands at 2.69%, down from 4.5% a year ago.

Meanwhile, the yield for 10-year Treasuries is 1.5%, down from 3% at the end of last year.

But even these paltry yields haven't soured individual investors on government debt. Intermediate-term-government-bond funds had more than $8 billion in net inflows in the six-month period ended June 30.

That is a big improvement from the previous 18-month period, during which investors yanked more than $9 billion more from such funds than they put in.

Despite the attention that investors are paying to Treasuries, bond managers who have the leeway to invest where they see the best opportunity are in stark conflict about whether to own the bonds.

BILL “BETTIN’ ON UNCLE SAM’ GROSS

Mr. Gross famously apologized last October for missing out on last summer's Treasury rally and seems intent on not letting history repeat itself.

This month he said that he is holding the percentage of Treasuries in the Pimco Total Return Bond Fund (PTTAX) at 35%, virtually in line with the benchmark weighting of the Barclays Aggregate Bond Index.

Treasuries represent the “cleanest of the dirty shirts” among sovereign debt, Mr. Gross wrote in a July 11 statement on Pimco's website.

“Market movements have confirmed it, and my own experience in 2011 is a testament to it. Don't underweight Uncle Sam in a debt crisis,” Mr. Gross wrote.

In Mr. Gross' corner is Ford O'Neil, portfolio manager of the $14 billion Fidelity Total Bond Fund (FTBFX). He began adding Treasuries to his fund in early 2011 and has about 30% allocated to the asset class.

“Our macro view right now is cautious,” Mr. Ford said. “There are a lot of factors right now that could be beneficial to Treasuries, such as Europe, the fiscal cliff and China slowing down.”

Mr. O'Neil isn't overly concerned about the long-term risks of owning Treasuries — namely rising interest rates or yields that fall short of inflation — because of how liquid the Treasury market is.

Mr. Gross isn't unaware of long-term concerns over Treasuries, despite the hefty weighting today.

“America's debt-to-GDP ratio is not near-term threatening but, if continued upward, could be absolutely debilitating,” he wrote.

DAN “FRETTIN’ ABOUT RATES’ FUSS

Mr. Fuss, portfolio manager of the $21 billion Loomis Sayles Bond Fund (LSBRX), has been warning investors that we have been in the “foothills” of rising rates since April. He thinks that the Treasury Department is keeping Treasury rates artificially low and that it won't take much of a move upward to cause a loss of principal.

“At some point, rates are going to start rising and there's just going to be a roar of pain when investors realize what's happening,” said Kathleen Gaffney, who co-manages the fund with Mr. Fuss. “We're not market timers, so we don't know exactly when it's going to happen.”

Bill Eigen, manager of the $12 billion JPMorgan Strategic Income Opportunities Fund (JSOAX), also has a zero allocation to Treasuries, primarily because he finds it hard to believe that they will repeat their 2011 performance.

“Last year, the only way to make money was to bet that all-time-low rates would go to new all-time-low rates,” he said.

Ms. Gaffney isn't willing to bet against Treasury yields' sinking to new lows this summer, but she isn't worried about missing returns if that happens in the near future.

“We're trying to position for the long term,” she said. “We don't mind looking foolish in the short term.”

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