Bond investors should prepare now for higher rates-Fuss

NEW YORK Fri Jan 11, 2013 1:25pm EST

NEW YORK Jan 11 (Reuters) - An extended period of rising interest rates is on the horizon and bond investors should adjust their portfolios while they can, bond market veteran Dan Fuss said on Friday.

"I've been saying for a long time that we are in the foothills of a rise in interest rates," said Fuss, vice chairman of Loomis Sayles & Co, with $182 billion in assets. "But I'd go a step further and say there's been a gentle rise in the foothills."

Markets pushed long-term Treasury yields higher last week after minutes from the last Federal Reserve meeting showed some participants thought it would be appropriate for the central bank to end an asset purchase program that has kept a lid on long-term rates.

Fuss, who has amassed more than 50 years of experience on Wall Street, said he worries most about the impact higher rates would have on high yield, or "junk," bonds issued by companies with high levels of debt.

Global central bank policies to keep interest rates low have prompted investors to overlook credit risks associated with some of these assets as they reach for higher returns, he said.

High demand pushed the average yield on U.S. high-yield debt below 6 percent this week for the first time, according to the Barclays Capital High Yield bond index.

"People say credits are getting so much better. That's baloney sausage. The credit cycle peaked a year and a half ago," Fuss said.

"What has got better - and it's very helpful to many issuers who would have had trouble accessing the market - is this push, push, push for yield ... As long as the flow of funds keeps coming, it prolongs the life of many marginal credits."

Fuss, who manages the Loomis Sayles Bond Fund, said that means investors should gravitate toward shorter-duration bonds and target companies with strong market share and growth potential.

"That will be the key in a rising rate environment," he said. "Someone might say, 'Well, that sounds like growth stocks.' That's right. You want the survivors."

Fuss said rates are not likely to rise sharply until the Fed starts to back away from its commitment to asset purchases and record low rates but warned that waiting too long will make it hard to adjust.

"When winter comes, if you're not prepared, you are in real serious trouble," he said.

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