| NEW YORK
NEW YORK Jan 9 Even with historically low bond
yields furthering talk of a "bond bubble," 2013 may not be the
time to abandon the Treasury market.
Despite the recent jump in the 10-year Treasury yield to
1.90 percent from 1.70 percent after the minutes from the latest
Federal Reserve meeting spurred a sell-off in U.S. government
bonds on hints that the Fed could pare its asset purchases by
the end of the year, investor demand for U.S. debt should remain
strong throughout the year, fund managers and analysts say.
The U.S. government is expected to reach its borrowing limit
by March, something that would threaten a U.S. debt default if
Congress does not act to raise the debt ceiling. A similar
standoff in the summer of 2011 led to one of the most volatile
weeks in stock market history and a rush into the safety of U.S.
Treasuries. A flare-up in Europe's lingering fiscal problems
would likely also spur a safety bid for U.S. government debt.
The Federal Reserve, meanwhile, is expected to keep the federal
funds rate near zero, keeping a lid on interest rates.
"You can't get a Treasury yield of 3 percent with a federal
funds rate at zero. It's just not going to happen," said Jim
Kochan, chief fixed income strategist at Wells Fargo Funds
Management. Treasury yields for the 10-year note should stay
below 2 percent for the rest of the year, he said.
But even if it makes sense to hold Treasuries, the current
yield of 1.85 percent for 10-year notes won't do income
investors much good. Fund managers are instead turning to
municipal bonds and emerging market debt for yield, and moving
into shorter duration securities to hedge against a possible
rise in interest rates.
A classic favorite of many retail investors has long been
the PIMCO Total Return Fund, the bond fund run by Bill Gross.
But on Wednesday one strategist, Steven Goldberg, of Tweddell
Goldberg Investment Management, told Reuters Insider that the
fund is too big to succeed.
PIMCO Total Return, which ranks as the world's biggest bond
fund with $285 billion in assets, earned a return of 10.36
percent in 2012.
Washington's deal to avert the fiscal cliff increased income
taxes on individuals earning more than $400,000 a year, a boon
for municipal bonds regardless of the debt ceiling debate. With
higher income-tax rates, investor demand will pick up for
tax-advantaged bonds issued in large states like New York,
California and Texas, said Jim Sarni, managing principal at
Payden & Rygel.
Municipal bonds should also benefit from scant supply of new
bonds. The total size of municipal debt issuance is expected to
stay steady at close to $400 billion in 2013, according to
estimates from Wells Fargo and Bank of America Merrill Lynch,
providing support for existing bond issues, even after the
Barclays Municipal Bond index returned nearly 6.8 percent in
The tax advantages of municipal bonds depend on where an
investor lives. California residents, for example, should opt
for a fund like the $423 million T. Rowe Price California
Tax-Free Bond fund, which yields 3.9 percent, while
New Yorkers should consider the $458 million T. Rowe Price NY
Tax-Free bond fund, which yields 3.6 percent. Funds
provide a hedge against the risk of a municipal bankruptcy or
default an individual security might bring.
Other fund managers are looking abroad for yield. Don
Quigley, portfolio manager of the $2 billion dollar Artio Total
Return Bond fund, is focusing on government debt
issued by Canada, Australia, Mexico and Brazil. These four
countries offer a combination of better yields and stronger
fundamentals than comparable U.S. government bonds, he said.
The 10-year Canadian bond, for instance, yields 1.92
percent, compared with a 1.87 percent yield for the comparable
Treasury note. Brazil, meanwhile, has a 10-year yield of 9.33
percent. For his Brazil position, Quigley is focusing on shorter
durations, which allows him to benefit from both the country's
appreciating currency compared with the dollar and from the bond
yields themselves, he said. Brazil's fundamentals, like a low
unemployment rate and the largest economy in Latin America, also
make it attractive, he said.
One popular fund option: the $7.9 billion PIMCO Emerging
Markets bond fund, which yields 4.3 percent and costs
$1.25 per $100 invested. The fund, which holds a mix of
dollar-denominated corporate and government debt, is one of the
least volatile funds among its peer group and emphasizes
countries with improving credit fundamentals, noted Miriam
Sjoblom, an analyst at Morningstar. Its top holdings include
securities issued by Russia, Bolivia and Venezuela.
Despite the concerns about the debt ceiling, some investors
are prepping for an improving economy by buying shorter-duration
corporate debt and shying away from exotic yield plays.
"The Fed is forcing investors out of U.S. Treasuries with
record low interest rates and into sectors they would not
normally invest in," said Jason Weiner, portfolio manager of the
$578 million BMO Aggregate Bond fund.
Once the debt ceiling showdown is over, Weiner plans to trim
his junk bond positions to focus on investment-grade corporate
bonds with one- to three-year durations. Shorter durations
should provide a cushion if interest rates - and the economy -
strengthen further as the housing market continues to improve,
Yet he acknowledges that it's a wait-and-see approach.
"Ultimately, we won't know if the economy can adjust to higher
taxes until the second half of the year," he said.