Investors had been feasting on U.S. corporate credit bonds for years, though recession fears and mounting defaults late last year put an abrupt end to that. This year, the appetite for U.S. corporate bonds picked up dramatically when investors’ views on the economy began to improve and central banks became more accommodative.
U.S. corporate bonds have posted a total return of 13.4% this year, measured by the Bank of America Merrill Lynch US Corporate Bond Index, while year-to-date Treasury returns are up 8.1%, according to an index compiled by Bloomberg and Barclays .
What’s more, a lack of alternatives against the backdrop of ultra-low, even negative-yielding, debt has made U.S. corporate bonds the natural destination for many investors. Some 95% of all investment-grade corporate debt in the world that has a positive yield is in the United States, according to Bank of America Merrill Lynch.
All three investors – Gundlach, the chief executive of DoubleLine Capital; Ivascyn, group chief investment officer of Pacific Investment Management Co, known as Pimco; and Minerd, global chief investment officer of Guggenheim Partners – have been underweight corporate credit relative to their benchmarks.
But all three told Reuters they can live with the underperformance because of the greater damage that they see coming for corporate bonds.
“We have never owned a single corporate bond in the Total Return Strategy dating back to 1993. Look it up,” Gundlach said. “When corporate bonds become very overvalued, especially when rates fall due to recession prospects increasing — well?” he added of why he has avoided the asset class.
The DoubleLine Total Return Fund (DBLTX.O), with $54.5 billion in assets under management, is up 6.17% this year, as of Aug. 23, according to Morningstar data. It is lagging its Intermediate Core-Plus Bond category by 2.50 percentage points, and lagging 90 percent of its peers this year, according to Morningstar. That Intermediate Core-Plus category invests primarily in investment-grade U.S. fixed-income issues including government, corporate and securitized debt, and has total assets of $724 billion.
Gundlach said there will be times when his fund will be out of favor and there will be times when it will be extremely popular. “Everybody knows what this fund is,” he said. “You know what you are getting. There are no surprises.”
Ivascyn, who oversees $1.84 trillion in assets under management at Pimco as of June 30, shares Gundlach’s sentiments. “We believe that corporate credit is fundamentally weak and could overshoot to the downside if the economy deteriorates,” he said.
The Pimco Income Fund (PIMIX.O), the largest actively managed bond fund, with assets of more than $130 billion, is lagging 93 percent of its Multisector Bond category so far this year, according to Morningstar data as of Aug. 23. The Multisector category typically invests in U.S. government obligations, U.S. corporate bonds, foreign bonds and high-yield U.S. debt securities and has assets of $259 billion.
Minerd’s Guggenheim Total Return Bond Fund (GIBIX.O) is lagging 95% of its Intermediate Core-Plus Bond category so far this year, for the same period.
“As the Fed begins its easing campaign to try to extend an already long-in-the-tooth expansion, credit spreads are already tight across the fixed-income spectrum,” Minerd said. “Credit spreads could get tighter in this liquidity-driven rally, but history has shown that the potential for widening from here is much greater.”
Gundlach, Ivascyn and Minerd have also played defense with their interest-rate postures, keeping their respective portfolios at shorter durations.
Duration is a measure of a bond’s sensitivity to interest rate fluctuations. Going shorter or negative duration is an investment strategy pursued when rates are expected to rise.
Ultimately, the three bond kings expect to win in the long run, as the economy weakens.
“We think developed government bond yields are too low and could easily reverse so we are comfortable with low rate exposure,” Ivascyn said.