Riding a booming bond market, long-duration fixed-income managers were able to outperform during the first quarter, according to the Pensions & Investments Performance Evaluation Report.
Diminished expectations that inflation was taking hold combined with the possibility of the Federal Reserve easing interest rates spurred long-duration managers to dominate the listing of the top fixed-income managers.
The rise in long bond prices this year comes on the heels of terrible performance in 1994, when rising rates produced negative returns. This year, the median long-duration manager posted a 6% return in the first quarter alone. And managers say the bond rally is continuing even stronger through May.
The next closest category of manager, convertible bonds, produced a median return of 5.7% in the first quarter. Even shorter-duration separate accounts posted respectable returns, with the median limited-duration account returning 3.2% and the median intermediate-duration account posting 4.2%.
For the same time period, a 30-year U.S. Treasury bond returned 6.6%, while 90-Day U.S. Treasury bills returned 1.4%. The Salomon Brothers Long Term High Grade Index rose 6.5% in the quarter, while the Salomon Broad Bond Index rose 5.1% and the Lehman Brothers Government Corporate Index climbed 5%.
Longer term, high-yield managers in PIPER continued to lead performance. For the year ended March 31, the median high-yield separate account manager led all categories, posting a return of 5.7%. Likewise, the median high-yield manager posted the highest return among all fixed-income management PIPER categories for the three-, five-, and 10-year periods ended March 31, with returns of 5.7%, 11.2%, 14.4% and 12.6%, respectively. All returns for periods of more than one year are compound annualized.
The bond rally this year came as a surprise to many, considering the losses experienced last year, managers said. Robert Payne, a senior partner in the San Francisco office of Loomis Sayles & Co. L.P., Boston, said the bond market has come to resemble a pendulum with rates swinging alternately higher and lower. After last year's swing to higher rates, this year the market is moving back to lower rates, he said.
As part of that, the rally has come quicker than expected. "We think this is where the market probably would (be) by the end of the year," Mr. Payne said. "We didn't think we'd get here in five months." Loomis' long-duration separate account was ranked eighth among long duration managers for the first quarter, and was ranked sixth for the year ended March 31.
Given that Loomis managers think interest rates are reasonable under current inflation expectations of 3% to 3.5%, they have shortened their average duration to between seven years and 7.5 years from previous levels of about nine years, he said. (Duration is a measure of the timing of a fixed-income security's cash flows).
Tarey Gabriele, senior partner for Executive Investment Partners, Fort Washington, Pa., said long-term interest rates are likely to continue falling because the economy is likely to go into a recession. "We do not believe in the soft landing scenario," said Mr. Gabriele, who termed it an "Alice in Wonderland" view of the market.
The market already is anticipating an easing from the Federal Reserve Board, with yields on three- and five-year Treasury securities trading below the Fed Funds rate as of the beginning of June, he said.
Yields on 10-year Treasuries could hit 6% by the end of June, he said, while the long bond could hit a 6% yield by September or October. Executive Investment's long-duration separate accounts were ranked third among all long-duration managers for the year ended March 31.
At Llama Asset Management Co., Fayetteville, Ark., managers decreased the durations of fixed-income accounts about a month ago after having had a "significant exposure to the 30-year area," said Rebecca H. Garner, president and chief investment officer. Before the current bond rally began, "we did not see the strength in the economy" that others saw, leading to expectations of higher inflation, Ms. Garner said.
Llama managed the fourth-ranked fixed-income account among long duration managers for the one-year period.
Mark Anderson, vice president for Renaissance Investment Management, Cincinnati, said the rally this year, particularly in May, was one of the swiftest in more than a decade. With the intermediate part of the curve rallying the most, there's still some opportunity for price appreciation on the long end of the curve, although, that's where the risk is too, he said. He said it was interesting the way the fixed-income market shrugged off concerns about a weaker U.S. dollar, which turned into "a non-event."
Renaissance's managers are moving portfolios into more defensive postures, giving the magnitude of the rally, he said. Renaissance managed the eighth-ranked long-duration PIPER portfolio for the one year period.
Anders Ekernas, president and chief investment officer for ABB Investment Management Corp., Stamford, Conn., said the rally is largely a reversal of last year's bear bond market.
Among long-duration accounts, ABB's long-duration government account was third for the quarter and 10th for the year.
PIPER data are compiled by Rogers Casey & Associates Inc., Darien, Conn.