US debt: money managers' least favorite investment
NEW YORK—Ask the people who invest billions for a living to name their favorite picks for 2012 and you'll get a smorgasbord worthy of a holiday party: Brazilian stocks, U.S. junk bonds, and government debt from Colombia. Ask them what they dislike and they'll name one of the top-performing investments this year: U.S. government bonds.
Investors can rattle off a long list of reasons to avoid Treasurys. They pay next to nothing and are bound to plunge in value whenever interest rates begin climbing from their historically low levels. It seems nobody likes Treasurys, yet everybody keeps buying them anyway.
"Our least favorite asset is Treasurys," said Christine Hurtsellers, chief investment officer for fixed-income at ING Investment Management during a recent press briefing. "We still have a lot, but it's hard to make the argument for them."
It's a tricky problem for bond-fund managers at a time when everyday Americans are trusting them with more of their savings. Among investors, there's a solid belief that Treasury prices must fall and push interest rates up at some point. But those who have bet on a Treasury market collapse this year got burned.
Bill Gross, the bond-world version of investment sage Warren Buffett, dropped nearly all Treasury holdings from the fund he manages at Pimco in early 2011. He argued that if Republicans held up lifting the government's borrowing limit, the country would risk default. Borrowing rates would spike as the world's investors dropped U.S. government debt, just as they have in Europe.
Most of what Gross predicted came true. The debt-limit fight raised worries about default and led to Standard & Poor's taking away the country's AAA credit rating in early August. But instead of spiking, U.S. borrowing rates plunged as traders sold everything else to buy U.S. government debt. The race into Treasurys helped drive the entire bond market up 3.8 percent from July to September. Gross got the big picture right but his big bet against Treasurys didn't pan out. Pimco's Total Return Fund lost 1.2 percent, its worst quarterly performance in three years.
It's been a recurring story since the financial crisis hit in 2008. For three years running, pundits have predicted that investors will eventually refuse to finance the U.S. government's $15 trillion in debt and the Treasury market will collapse. But worries over the U.S. economy and the perilous state of Europe's financial system keep drawing banks and money managers from around the world back to the U.S. dollar and Treasurys.
That demand continues to push U.S. government bond prices up, the main reason why the Treasury market has returned 8.5 percent this year, despite microscopic yields, according to Bank of America-Merrill Lynch data. The benchmark for stock market funds, the S&P 500 index, has returned less than 1 percent, including dividend payments, and that's with a 7.4 percent surge over the past week.
"It's been a pretty strong year for bonds," said Michael Gitlin, director of fixed income at T. Rowe Price, "and it's largely a result of Treasurys."
Judging by the gauges money managers usually check before making a move, buying Treasurys still looks like a bad idea. Consider this sample:
(asterisk) The benchmark 10-year Treasury pays just 2 percent a year. Take inflation into account and the payout on Treasurys equals negative 1.5 percent, what finance types call the real rate.
(asterisk) Treasury yields pay less than top-grade corporate bonds at 3.7 percent and even less than the stock market's 2 percent dividend yield.
"My colleagues say there's little value in 10-year (Treasurys) and I'd agree," Gitlin said. "People have been saying there's a fixed-income bubble. No, there's a Treasury bubble."
If there's so little to like about U.S. government bonds, why are the world's investors still buying Treasurys instead of dumping them? In a word, it's Europe.
As the crisis seemed to spread from country to country this year, the world's traders plowed more money into Treasurys. The higher the demand for U.S. debt, the lower the interest rate, or yield. So when it looked like Greece might default on its debts earlier this year, the yield on the 10-year Treasury note sank below 3 percent. And when attention turned to Italy and its government debts the yield sank even further, dipping below 2 percent in September. The shift of money out of Europe and into the U.S. has pushed Europe's borrowing rates to dangerous levels while causing U.S. interest rates to sink.
"You can hate the budget situation and hate the low yield, but if there's a panic it's the asset that outperforms," said Robert Robis, head of fixed-income strategy at ING Investment Management.
A good reason to hold Treasurys, in other words, is that the Treasury market remains the world's favorite hiding spot. So, for many fund managers Treasurys aren't exactly an investment. Buying Treasurys is like taking out an insurance contract, Robis said. They're protection against global financial trouble.
The ING Global Bond fund, for instance, has 15 percent of its $641 million in Treasurys, less than the 20 percent in the benchmark Barclay's bond index. Robis said having none would be like betting European governments will come to a quick solution to the region's debt crisis and that the U.S. economy will soon recover its health.
"There's still a need to hold Treasurys," Robis said. "Just don't expect to make a fortune off them."