In an investment career spanning more than half a century, Dan Fuss has seen more peaks than there are mountains in the Colorado Rockies and witnessed market comebacks of the scale that would make even Madonna blush.
The vice-chairman of Loomis Sayles and fund manager of the $24 billion Loomis Sayles Bond Fund, Fuss is what you would describe as an ‘old school’ investor, or as one colleague recently referred to him, ‘the last of the old discount bond buyers’.
‘My number one rule is: I never pay par for a bond,’ he tells me, holed up in his Boston headquarters as snow continues to tumble down during one of the harshest winters the city has experienced in decades.
‘The market is like the weather we are having now. Once in a while, there is a polar vortex. We have had a miniature one here over the last few months, notably on the credit side early in the fourth quarter and, right now, on the currency side.
‘The leverage in the market and the asset flows, particularly in the high yield area, provide these mini polar vortexes. Once in a while, like Boston here in recent weeks, you get the “big one”, and you get twice the amount of snow you are meant to get in an entire winter in a couple of weeks.’
Fuss originally joined Loomis Sayles back in 1976 and has been managing his blockbuster global bond fund since its inception in 1991. He is also a named manager on the US corporate high yield fund, Loomis Sayles High Income and the US dollar bond fund Loomis Sayles Multi Sector Income fund, among others. Looking back over the past 10 years, the performance of his Bond Fund has been nothing short of impressive, generating returns of 106%, more than double the 43.7% rise of its Citywire-allocated Barclays Global Aggregate bond benchmark.
Fuss’s wealth of experience shines through throughout our discussion. After all, it is not very often that you get the chance to speak to a manager who can recall first-hand the effect the Watergate scandal had on the bond markets. He is still firmly in touch with the goings-on in today’s market and tells me that, for him, the major market dimension affecting bond investors at present is geopolitical risk and the rush to safety this has subsequently caused.
‘Right now, we have geopolitical stress in the world, in Eastern Europe and the Middle East, and, if we had been talking a year ago, we would have been talking about the South China sea,’ he says, referring to the ongoing dispute between China, Japan and South Korea regarding the extent of their respective territories and economic zones.
These events have led to increased money flows to North America, particularly the US, as investors seek safer shores. This influx of investor cash is one of the things driving the strength of the US dollar.
‘The money had been flowing towards US Treasuries in particular and high-quality corporates. Until recently, the money has gone towards the long bonds.
‘The reality is you had a fund flow for safety towards the US dollar and it worked its way round the curve. There was an interim period of about three weeks where it seemed that maybe that was over. But it is now strengthening again.’
His fund is heavily exposed to the US dollar, about 77% of his currency allocation, and is a blend of developed government bonds, blue chip corporates as well as a high exposure to high yield credit, the latter accounting for about 27% of his fund.
The oil price has also had a strong effect on bond investors’ portfolios, but Fuss believes we are nearing the end of that particular market stress.
‘It does look as if the price of oil may well have bottomed. There are many other factors, but the mid-$40s could have been a bottom. That extreme put pressure across markets on the credit side and on oil-based credits. That might now be backing off a bit.’
So how has this rush to safety over the past year affected him as a bond investor?
‘Not well,’ he tells me. ‘Around a year-and-a-half ago we started building up, buying reserves. At its peak, the Bond Fund was up at about 26% invested in short governments. Right now, it is sitting at 20%.’
In October of last year, Fuss and his team put some of that money to use, hence the drop in reserves, taking advantage of the sell-off to buy some discounted high yield debt.
‘We still have room to run in high yield, but that market is reasonably pricy. There are not too many bargains. The bargains are in the energy space, but the credit picture has changed remarkably there and the first wave of that means all from Exxon Mobil on down got hit.’
He insists there is no theme driving his high yield purchases. Rather, he has been finding individual opportunities that meet his discounted demands. His interest in this sector should not be mistaken for being bullish on its outlook, he says, adding that he has also liquidated some high yield positions recently.
‘I’m far less comfortable in high yield right now than I can recall. I don’t recall being this nervous about high yield ever.
‘That doesn’t mean there aren’t some individual opportunities, but I see a lot of leveraged money in the high yield market. I see periodically a very indiscriminate bidding for new issues.
‘I keep my shirt buttoned up because I’ve gotten scars all over me dealing with, what I would call in hindsight, irrational markets.
‘The high yield market is more than somewhat irrational right now because of the levered money in there and the money coming through from open-ended mutual funds and exchange-traded funds.’
Improving fundamentals have led many investors to flock to the high yield sector, but Fuss warns that upcoming policy changes could hit the sector hard.
‘There is so much money coming into high yield that these companies refinance. They had very stretched balance sheets and they have brought down the cost of their fixed capital to a point where they can survive. That will not continue once interest rates start up.’
On the subject of rate rises, an unavoidable topic in our current market environment, what is his take on when it will happen?
‘For domestic reasons alone, if the US existed in isolation, the central bank would certainly be looking at starting to let short rates come up now,’ he tells me. ‘There is a lot of pressure in the system to have them raise rates coming from most of the banks, not just the big ones.’
While the Federal Reserve’s mandate is clearly defined as being a domestic mandate, in practice that is harder to implement, says Fuss, and the delay is likely to be more linked to the knock-on effect this would have on other regions.
‘The principal risk that you have by letting rates start to go up in the US is it is taking more money out of the areas that need the money for development, the emerging market area, particularly Latin America to a small degree and South East Asia to a large degree.’
While rising rates represent an important factor in his bond outlook, Fuss’s greatest concern is still on the global stage.
‘The overriding issue is definitely the geopolitical side. That drives the US Treasuries bond requirement, defense spending and so on, and also drives most of the major risk factors for investment.’
Aside from tweaking his high yield exposure, Fuss says he has also been making adjustments to his investment grade positions, among other things.
‘We have not been buyers of non-US dollar positions. That portion of our portfolio has actually slowly been shrinking. We have made some changes there, which we tend to be doing a year in advance of the market, same with high yield.
‘The punchline is we like to bring a bid to an illiquid market. We do find the anomalies and our turnover is fairly low, in the mid to high 20s, which is low for a fixed income portfolio.’
The Boston manager’s 10-year performance makes for impressive reading, the only blemish being his notable drop during the financial crisis when he had exposure to the banking sector and also to Fannie Mae. All investors saw their portfolios hit during that period, with some scrambling to try to shore up their portfolios, so how did Fuss deal with the situation?
‘We didn’t do anything at all different, but how you deal with the pressure points in the market is critical.’
At that time, his exposure towards high yield credit was in the high 20% region and his exposure to non-US dollar positions was higher than today’s level of about 18% and was mainly focused on the Canadian dollar. He was also buying busted convertibles at the time.
‘None of those things were really helpful the fall of ’08. They were all helpful in Q1 and Q2 the following year.
‘My flip way of dealing with it is “same bonds, new prices”, so the prices were marked down a lot. When things started to recover in 2009, prices were marked back up. If you took a slice of the portfolio at the end of September ’08 and looked at that same slice at the end of March ’09 or June ’09, it hadn’t changed much.’
MOST MEMORABLE MOMENT: WATERGATE
‘I’m going back to 1973-74. What’s not well known about me is that I have run a fair amount of money on the stock side over the years.
‘At that time, on both the bond and stock sides, I started becoming more aggressive. I handled the first part well; the blow off and the Nifty 50 growth stocks in ’73, and I was feeling pretty smug. Boy, was I wrong.
‘I put the money in cyclical stocks. That did fairly well. On the bond side, I was busy buying busted convertibles because, while the Nifty 50 were going up, most stocks were going down.
‘Then the stock market really kept sliding. Corporate bonds and Treasuries were sliding. It was Watergate and the market itself was deteriorating and I was busy buying. I was 100% long and the market just kept going down.
‘I remember the day the market bottomed. It was the first Friday of October 1974. I had a big client meeting that morning in which I assured them that the market was in a bottoming process and there was nothing to worry about. They were getting mad at me and I thought I was going to lose the account.
‘Well, that was the bottom.
‘Somebody on that account went around saying for years that they had a bond manager that had called the bottom of the 1974 market! I was just trying to save my skin and get out of that meeting alive.
‘My mistake was buying too early. It got much worse than I thought it could. It got worse because the Watergate scandal got worse and led to the resignation of the President. The impact of that on the psychology of the market was the thing I wasn’t understanding.
‘The best thing I did was to hold my ground. I said, “This represents extreme value. We are buying bonds on 55 cents on the dollar that are worth $1.08, by my calculations, and because they were being liquidated.”
‘At the end of ’74 and start of ’75, if you had looked at it, you would have thought I had done well. But it is what happened in-between.’