With new fund, Eaton Vance bond manager tops market
NEW YORK (Reuters) - Not long ago, Kathleen Gaffney was considered the obvious successor to bond guru Dan Fuss, with whom she co-managed the $21.9 billion Loomis Sayles Bond fund for nearly 20 years.
Now, for the first time since Gaffney jumped to competitor Eaton Vance and opened her own fund earlier this year, she is beating him.
Gaffney's $171 million Eaton Vance Bond fund returned 7.6 percent for the year through November 3, the best performance of any of the 319 multi-sector bond funds tracked by Morningstar. The Loomis Sayles fund, meanwhile, came in second with a 7.5 percent return.
It's an early strong performance for a bond fund manager who doesn't particularly like fixed income at the moment.
"The prospects for equities are more attractive right now," Gaffney said, citing the growing U.S. economy. As a result, she has approximately 15 percent of her fund's assets invested in stocks directly, while another 15 percent is in convertible bonds that can be turned into equities.
Some of the largest positions in her portfolio include shares in the stock of glass-maker Corning Inc and chip-maker Intel, and bonds that can convert into the stock of companies such as Chesapeake Energy and Goodyear Tire and Rubber. And she plans to add more European stocks to her portfolio soon.
Her focus on stocks is in large part due to the dim outlook for the bond market. As the Federal Reserve prepares to pull back on its bond-buying stimulus program, interest rates are widely expected to rise and cut into returns for fixed income.
As a result, multi-sector funds like Gaffney's, which have the freedom to invest in nearly any corner of the bond market and typically allow up to 20 percent of their portfolios to be invested in stocks as well, have become popular. Nearly $20 billion flowed into the category in 2012, according to Lipper, and investors have moved an average of nearly $10 billion a year into multi-sector funds over the last five years.
Her stake in convertible bonds is well above the category average of just under 1 percent of assets. Gaffney says that these securities are more attractive than junk bonds, whose yields hit a record low earlier this year in large part because the Federal Reserve's bond buying stimulus program pushed income-hungry investors into riskier debt.
"The valuation of the underlying equities are attractive," Gaffney said, compared with junk bonds where "you are not getting compensated for the credit risk that you're taking."
Her stake in equities isn't the only thing that sets Gaffney's fund apart. Where most bond managers focus conservatively on what could go wrong, Gaffney concentrates aggressively on where she thinks things could go right.
Only 15 percent of her portfolio is invested outside of the United States, which she says has the best growth prospects in the world right now. Half that percentage is in short-term Canadian government bonds that she uses as an alternative to U.S. Treasuries because they offer higher yields and a proximity to the U.S. economy.
Mexico makes up her second largest foreign position. Thanks to recent reforms that will make its energy and telecom industries more competitive, the country is "positioned in the sweet spot for what types of characteristics investors should look for," Gaffney said.
In all of her positions, Gaffney is looking for value. She recently added to bond positions in the metals and mining sector, for example, after commodity prices fell due to concerns about a slowdown in China. Gaffney wasn't fazed, in part because companies have an ability to adjust production over the long run and stabilize prices, she said. A position in Cliffs Natural Resources is now the eight-largest in her fund, according to Morningstar data.
She also expects to add to her positions in both European stocks and corporate bonds. "There are a number of elections over the next 12 to 18 months that have the potential for reform, and if that catches on, it will create potential for some significant headwinds," she said.
While Gaffney's fund is off to a strong start, it may be too soon to judge it a success, said Todd Rosenbluth, director of mutual fund research at S&P Capital IQ.
"We generally don't think investors can credit a manager of a new fund for the performance and track record of their old fund," he said. "There are too many variables, and it's a new team of analysts and flows that can affect returns."
Investors who want to jump in to Gaffney's fund will pay an average fee of $1.00 per $100, an expense ratio that Morningstar considers below average. Some share classes will also pay a sales load charge between 1 and 4.75 percent.
(Reporting by David Randall; Editing by Leslie Gevirtz)