November 22, 2013 / 9:01 PM / 4 years ago

REUTERS SUMMIT-Laggards in 2013, bonds may be set to shine

(For other news from Reuters Global Investment Outlook Summit, click on: here)

By Luciana Lopez and Jonathan Stempel

NEW YORK, Nov 22 (Reuters) - Bond investors have had little reason to cheer in 2013. Conflicting signals from the Federal Reserve and uncertainty about the global economy have made debt markets a tough place to rack up returns.

And yet, bonds, not stocks, emerged as a favorite of several big money managers at this year’s Reuters Global Investment Outlook Summit.

Speakers singled out commercial mortgage-backed securities, high-yield corporate debt and selected municipal bonds as potential standouts for the year ahead.

Economic uncertainty, a still-fragile jobs market, and expectations for extensive monetary stimulus under Janet Yellen, President Barack Obama’s nominee to head up the Federal Reserve, who is expected to win full Senate confirmation next month, were cited as factors that could make bonds a decent bet in what could be a potentially stormy 2014.

“If you don’t diversify against the risk of the equity markets bubbling ... if you’re not looking at the macro level statistics, if you’re not tracking the economy relative to the market, you’re going to make big mistakes in 2014,” said Daniel Alpert, managing partner at Westwood Capital, a New York-based boutique investment bank.

Alpert declared himself a “bond bull” in the coming year.

U.S. Treasuries prices have sunk for much of 2013, taking yields on benchmark 10-year notes more than 100 basis points above their low point for the year in May. Total returns for many bond indexes are negative for the year, with notable exceptions including high-yield debt and short-dated mortgages.

The economic figures have been mixed -- jobless claims have fallen and inflation remains subdued, but manufacturing has been patchy and the housing market’s momentum has slowed of late. All that points to a sluggish economy next year.

That’s a challenge for everyone from central banks looking to withdraw crisis-era support measures to investors looking for gains in a potentially choppy market.

The Fed wants to slow its $85 billion of monthly purchases of U.S. Treasuries and mortgage-backed securities. But when and how that tapering will happen remains uncertain, particularly after dovish remarks from Yellen, the current Fed vice chair, who is nominated to succeed Ben Bernanke as the central bank’s chief.

“There is much greater uncertainty in how the Fed will behave next year,” said Deepak Narula, founder of Metacapital Management LP in New York, who oversees $1.45 billion. His main fund last year returned more than 40 percent.

Yields on U.S. Treasuries have shot up since Bernanke began hinting at a policy exit in May. That, in turn, has driven yields on riskier debt instruments up, said Bonnie Baha, head of global developed credit at DoubleLine Capital in Los Angeles, which invested more than $56 billion as of June 30.

“When the market backed up, I guess early to mid-summer, we took some money away from investment-grade corporates and put it into the high yield corporate space,” Baha said.


Some investors see value in junk-rated debt from J.C. Penney Co Inc as the retailer tries to recover from a failed plan to end discounting and move up-market, which led to plunging sales and big losses.

“You’ve got a huge opportunity on the debt side,” said Marc Lasry, chief executive of New York-based hedge fund firm Avenue Capital Group, which invests $12 billion.

Lasry said if J.C. Penney can generate a mere $150 million of annual earnings before interest, taxes, depreciation and amortization, it can cover interest payments on its debt. “It shouldn’t be that hard over the next year or two,” he said,

Some money managers see value in municipal bonds. Investors dumped municipal debt wholesale this year on worries about Detroit’s bankruptcy filing and Puerto Rico’s shaky finances, which Colin Teichholtz, co-head of fixed-income trading at hedge fund firm Pine River Capital Management in New York, termed a mistake.

“The muni market is one that’s very prone to throwing the baby out with the bath water,” he said.

Teichholtz said Pine River, which has $14 billion under management, has scooped up bonds from Puerto Rico’s Corporación del Fondo de Interés Apremiante (Cofina) which, unlike general obligation bonds backed by issuers’ taxing power, are backed by sales tax receivables.

Municipal debt also brings tax benefits to investors, said Dan Fuss, vice chairman of Loomis Sayles & Co in Boston, who oversees $193.5 billion.

“If you’re a taxpayer, depending on the state and the city you live in, the market that I can think has the best potential in a rising interest-rate environment is actually the municipal bond area,” he said.

Even the mortgage market is seen holding opportunities. Jeff Kronthal, co-founder of KLS Diversified Asset Management LP in New York, likes commercial real estate securities. Defaults, liquidity and underwriting have all improved there, he said.

Double-B rated commercial real estate securities now yield about 5 or 6 percentage points more than similar U.S. Treasuries, Kronthal said, while similarly rated corporate debt carries a premium of only about 3 percentage points. “Is that really the right spread?” he asked. (Reporting by Luciana Lopez and Jonathan Stempel in New York; additional reporting by Sam Forgione; Editing by Leslie Adler)

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