Bond fund managers offer contrasting views on the outlook for rising interest rates

Bond investors: Concern over higher interest rates

CHICAGO — Bond investors beware: Fear is high that an inevitable increase in interest rates will spell doom for bond returns, eroding income from an increasingly popular source of savings for Americans.

It’s a timely concern because investors seeking refuge from stock market volatility have poured more than $500 billion into bond mutual funds and exchange-traded funds over the past year and a half.

Bonds may soon become less popular because interest rates have nowhere to go but up. The Federal Reserve has been holding rates near zero since December 2008 to encourage spending and lift the economy out of recession.

At some point, those rates must creep up, or the government risks fueling long-term inflation. Policymakers are in no rush to head off that risk. Last week, the Fed pledged again to maintain record-low rates for an “extended period.”

When the Fed eventually budges, the risk for fixed-income investors is that bond prices will drop as interest rates creep up. Bonds will be worth less because other investors can buy newly issued bonds paying higher rates. Individual bonds and bond mutual funds alike would be hurt.

So how worried should investors be about higher interest rates, particularly if they hold safe-haven assets like Treasurys that have been in high demand lately?

Two bond fund managers were asked to respond to the question Friday at the Morningstar investment conference. Here are excerpts from their answers:

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Curtis Arledge is chief investment officer for fixed-income with BlackRock Inc., and manager of two BlackRock funds: Total Return (MDHQX) and Strategic Income Opportunities (BASIX). He’s far less worried than many that the Fed will raise rates this year, and thinks an increase is more likely next year.

Arledge acknowledges the Fed faces rate-raising pressure because the record level of government spending may fuel inflation.

But he argues that the pressure from heavy government borrowing is being offset by reduced private borrowing — both from corporations issuing fewer bonds and from consumers taking out fewer loans. As a result, overall borrowing is down sharply over the past three years.

That reduction, and the continuing slow pace of economic recovery, reduce the risk that the Fed will raise rates soon, Arledge says.

He predicts rates to remain low “for a long period of time,” without offering a specific time frame for a rate increase.

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Michael Hasenstab, manager of the $34.7 billion Templeton Global Bond Fund (TPINX), sees rising rates as an immediate risk because Congress and other government policymakers appear unwilling to take the painful steps needed to rein in federal borrowing and reduce deficits.

He worries that the Treasury market will eventually become saturated, with fewer investors willing to buy government debt with returns so low. That would put pressure on the Fed to raise rates sooner rather than later, even absent the risk of inflation if the economy comes roaring back.

That’s why Hasenstab’s fund portfolio holds no Treasury debt.

“We see lower-hanging fruit elsewhere,” he said.

His fund invests in fixed-income globally, and he prefers buying debt from other countries whose governments face far smaller debt burdens, like Australia.

Buying U.S. Treasury debt, he says, is akin to making a bet that “politicians will get it right and stop spending so much” — a bet he’s unwilling to make.