99% of Bond Investors Made Mistakes That Sank Their Rivals

In 2022, the bond market proved to be a formidable opponent for Wall Street's most experienced investors. Despite their best efforts, many bond fund managers were met with significant losses due to the unexpected and drastic rise in interest rates.

Apart from Scott Solomon and William Eigen.

Out of the 198 bond funds in the United States that manage a minimum of $1 billion, only two have been able to show a positive return this year. These two funds are the T. Rowe Price Dynamic Global Bond Fund and the JPMorgan Strategic Income Opportunities Fund.

This year, only two bond funds have seen positive results.

Both men had similar approaches to success. They were able to identify the issues with the idea that inflation was only temporary, which allowed them to protect their portfolios from the Federal Reserve's tightening cycle. Solomon, who works with Arif Husain in London, used derivatives to make money and guard the portfolio as rates increased. Eigen, on the other hand, sold off risky bonds and put the money into cash.

At present, bond managers are observing their competitors making a major misstep. They believe that the mistake is taking the evidence of decreasing inflation as a sign that the Federal Reserve will start searching for chances to reduce rates after they have finished increasing them, in order to prevent a severe economic downturn. This sentiment is what has caused the recovery of Treasuries since the beginning of November.

Despite core inflation being at 6%, three times the Federal Reserve's target, Solomon and Eigen do not think policy makers will be quick to reduce rates. Jerome Powell, the Fed Chair, expressed the same sentiment last week, refuting the market's expectation that the Fed would quickly reverse its decision to raise borrowing costs at its seventh consecutive meeting.

Eigen warned that the Federal Reserve has unleashed the inflation genie and it will be hard to contain it.

Solomon stated that the Federal Reserve's worst-case scenario is an inflation rate that drops and then rises again, which is why they will be hesitant to announce major cuts. He noted that not many investors are taking this risk into account.

At present, both managers are adhering to the defensive approaches they established in the latter part of last year.

The results of the 198 funds that were analyzed using data from Bloomberg and Morningstar Direct have proven to be accurate. The average return of these funds, excluding short-duration offerings, is a loss of 11.5% this year through Dec. 16. However, the T. Rowe fund with $4.5 billion in assets has gained 3.4%, and JPMorgan's $9.2 billion fund has earned 0.3%. This is similar to the stock market, where a wise decision on inflation has led to rare gains.

Over the past five years, the T. Rowe fund has achieved an average annual return of 2.7%, outperforming the majority of its peers, as reported by Bloomberg. The JPMorgan fund has also seen success, with an average annual return of 1.6%, which is better than the majority of its peers. This is in contrast to the Bloomberg USAgg Index, which has seen an average annual gain of 0.3%.

The second-best investments this year have been those that were able to minimize their losses.

Lindsay Rosner, a member of the group of investors that manage the PGIM Absolute Return Bond Fund, has admitted that they began the year with the expectation of inflation.

Once they realized their mistake, they quickly shifted their strategy and unloaded their longer-term bonds, which were the most affected by the increase in rates. At one point, they reduced the duration of their fund to zero and still had around 6% in cash or its equivalent as of November 30th. Their $1.4 billion fund has experienced a 1.4% loss this year.

The consumer-price report from last week revealed a deceleration in a core inflation measure for the second month in a row, according to Rosner, who cautioned against taking this as an invitation to act.

Eigen is more aware of what is happening in the everyday lives of people than many of his contemporaries.

He has a business in the New England region that is related to athletics. During the summer of last year, he observed that expenses, ranging from food to gym equipment, were increasing. This led him to the realization that the inflation rate was not temporary, as the Federal Reserve had been asserting.

In the beginning of the year, he began to divest from the riskier investments in his portfolio, such as high-yield bonds. By the end of January, the fund had moved more than 60% of its assets into cash, which yields a return that increases as the Federal Reserve increases rates. By late November, that percentage had risen to 72%.

According to Eigen, there is no indication that the cost of running his facility will decrease. He has difficulty finding and retaining workers, which leads to him having to offer higher wages in order to attract them.

Eigen has not found yields to be appealing enough to exchange for his cash. In the past, Treasuries have increased in value during an economic downturn as the Federal Reserve decreased borrowing costs, however, he noted that this may not be the case this time due to higher inflation. He is waiting for potential market openings that may come about as the Fed tightens its grip on lower-rated corporate debt.

John Eigen expressed his opinion that the Federal Reserve will not be quickly reducing interest rates by the middle of 2020. "I just don't see it," he said.