bear markets

Here comes the bear market for bonds

April 18, 2012: 5:00 AM ET

What Scott Minerd of Guggenheim Partners is doing to prepare for the lean times in fixed-income investing.

Interview by Amy Feldman, contributor

Scott Minerd, Guggenheim Partners

Scott Minerd, Guggenheim Partners

FORTUNE -- Guggenheim Partners chief investment officer Scott Minerd is a financial-history buff with a record of making dramatic predictions. In 2005 he warned clients of a looming cataclysm, and then was buying bonds again by October 2008. Those calls have helped the firm -- founded by the grandson of Solomon Guggenheim -- increase assets to $122 billion at the end of 2011, from $35 billion in 2007. Its fixed-income composite has returned an annualized 7.4% for the decade ended Dec. 31, ranking it in the top percentile of eVestment Alliance's U.S. core fixed income. Now Minerd, 53, says bonds are headed for a long-term bear market. (For more on bonds, see Allan Sloan's column.) He spoke with Fortune from his offices in Santa Monica about the economic outlook, where he's finding opportunities, and how his life has changed since a Guggenheim-led consortium reached a deal to buy the Los Angeles Dodgers. Edited excerpts:

You think a generational bear market for bonds is coming -- why?

We're coming out of a generational bull market, and I believe rates for Treasury securities have traded at their lows. Over the next three to five years, I expect rates to move up significantly [which means bond prices will drop]. The Fed's policy has been to maintain very low mortgage rates to help clear the inventory in the housing sector. We expect the overhang in housing to be cleaned up by 2015. At that point the Fed will realize that inflation is becoming a problem and will begin to raise rates, and that'll be the beginning of the generational bear market.

So we're not quite there yet, but moving toward it?

That's right. If you bought Treasuries and held them for the past 30 years, your returns have been quite attractive, probably in excess of the return you would have had if you'd invested in equities. But now the upside is limited, so it's time for investors to move away from Treasuries if they haven't already begun to do so.

So should investors rid their portfolios of Treasuries?

It's always hard to eliminate an asset class because I'm a staunch believer in diversification. But if you push me hard enough, I'd tell you that I would have no allocation to Treasury securities at this point.

Where are you putting money instead?

There are a number of sectors that are still really attractive. Investment-grade bonds and below-investment-grade bonds will definitely outperform Treasury securities. In addition, certain securities have substantial liquidity premiums. They're not readily buyable or sellable at any given moment. The most interesting part of that world is asset-backed securities, infrastructure debt, and commercial mortgages. So, for instance, the five-year Treasury is approximately 1%, yet you can buy a five-year commercial mortgage at 5.25% on an A-class property that has a 70% loan-to-value ratio. You're beating five-year Treasuries on an annual basis by 425 basis points. That excess return over five years accumulates to 23% more income than Treasury securities.

Where else are you investing?

We're moving into floating-rate securities. There are some, indexed to LIBOR [the rate London banks use to lend to one another], with yields north of 5%. We see access to these floating-rate securities as a way to maintain our portfolio yields. A 5.25% yield on a commercial mortgage is very attractive, but a 5.25% yield on a floating-rate security may be more attractive. I'll state the obvious: The floating rates cannot reset meaningfully lower [since the Federal Reserve has already lowered short-term rates to close to zero].

In addition, we have looked to use our fixed-rate capacity to buy high-yield bonds, asset-backed securities, and some investment-grade corporate. There have been a number of corporate bond deals in the past month or so, and we have 65 people dedicated to corporate credit who can analyze them. An example would be Energy Transfer Partners (ETP), which is a pipeline transmission company. That bond was at a 4.6% yield to 2022.

What else have you bought recently?

We recently invested in asset-backed bonds sold by Domino's Pizza (DPZ), secured by the royalties on the domestic and international franchises, and all their intellectual-property assets. That was 5.25% for seven years, with a BBB-plus rating. Domino's has grown revenues and earnings even during the crisis, and is expanding heavily in the overseas markets.

What are you selling?

Very-short-maturity, high-grade investment names. There are a lot of corporate bonds in the sub-five-year maturities trading at 1% to 2%. Given the return, it doesn't make any sense to hang on to them.

With the Guggenheim-led deal to buy the Dodgers, I guess you'll be going to more baseball games now.

The acquisition of the Dodgers has made me the most popular person in Los Angeles. Everywhere I go, I'm a celebrity now. When the news broke, my phone didn't stop for four hours.

This story is from the April 30, 2012 issue of Fortune.

Current Issue
  • Give the gift of Fortune
  • Get the Fortune app
  • Subscribe
Powered by WordPress.com VIP.