With inflation apparently tamed, fixed-income managers anticipate a bright future, following an already strong performance from bonds so far this year.
Money managers say that despite the down market of 1994, the double-digit fixed-income returns this year reflect a larger trend of falling inflation. And as inflation continues at low levels, interest rates are likely to fall even further, possibly below 5% for long-term bonds, some managers say.
Perhaps overshadowed by the extremely high returns seen in the stock market, fixed-income managers also report high returns. The median fixed-income manager for the first three quarters of 1995 posted 12.6%, according to Pensions & Investments Performance Evaluation Report. At the same time, the Lehman Brothers Government Corporate Index was up 14, while the Salomon Broad Bond Index was up 13.6%. The 30-year U.S. treasury bond returned 22.7% for the same period.
More recently, the median third-quarter PIPER manager returned 1.9%, matching the Salomon and Lehman indexes. The 30-year treasury bond was up 2.6%.
Productivity has been growing faster than demand, keeping prices down, said Anders Ekernas, president of ABB Investment Management, Stamford, Conn. Production capacity has effectively increased 4% a year because of productivity gains, resulting in "pricing power being eroded in virtually every line of business," Mr. Ekernas said. "We expect that to continue for the next several years," he said.
ABB's long-duration separate accounts were ranked No. 3 by PIPER for the year ended Sept. 30 with 31.3% - more than double the 14.1% of the Salomon index and 14.4% of the Lehman index.
"Those returns were reflective of the fact (that) we felt that the market was overly concerned about inflation pressures and therefore pushed up bond yields way too high by late 1994," he said. Mr. Ekernas said ABB purchased securities very sensitive to changes in interest rates and pushed its duration out 40% longer than its benchmarks to position portfolios for a fall in rates.
"We still believe there's room for bond yields to move lower still," he said.
Other money managers agree that inflation is not likely to pose a threat. Alan Kral, vice president for Trevor Stewart Burton & Jacobsen Inc., New York, said: "Inflation will be low and stay low for quite a while." The discipline of the markets is pushing the Federal Reserve to maintain interest rates at levels that keep inflation under control, he said.
Mr. Kral said inflation rates should stabilize at less than 2% a year. And if interest rates fall and then a recession kicks in, long-term interest rates could drop below 5%, he said.
Trevor Stewart's fixed-income composite ranked fifth among PIPER managers for the year with 27.9%.
Van Hoisington, president of Hoisington Investment Management Co., Austin, Texas, said U.S. economic growth should be minimal, keeping inflation at bay. "We are looking for zero growth or worse" in the first half of 1996, and annual inflation of about 2%, he said.
Hoisington's 29% fixed-income composite was ranked fourth among PIPER fixed-income managers for the year ended Sept. 30.
Mr. Hoisington uses a strategy of full investment in or full divestment of longer-term U.S. treasury securities, and currently is fully invested. He said he is likely to remain fully invested over the long term, until one of two things occurs. If the market fully discounts existing inflation pressure, or if there is a significant Fed policy shift that raises the specter of inflation to a high degree, he is likely to move out of the market, he said.
Michael Kayes, chief investment officer for Eastover Capital Management Inc., Charlotte, N.C., said: "My sense is that low inflation is going to be here for a while." Eastover's fixed income plus-cash portfolio was ranked sixth among PIPER fixed-income managers, with a return of 26.6% for the year.
He said the long-term government bond yield is likely to remain in the 6.8% to 6% range. A lot of what happens will be determined by corporate earnings growth, which will give investors clues as to what economic growth will be, Mr. Kayes said.