Absolute Return Bond MF Beats HFs

Chidem Kurdas

This July American Beacon launched its Flexible Bond Fund, joining the small but growing group of absolute return-targeting mutual funds. An investor could consider this vehicle as an alternative to fixed income hedge funds. It goes long/short and uses derivatives. The managers are Brandywine Global Investment Management, GAM International and PIMCO.

David Hoffman, portfolio manager at Brandywine, says they’ve been invested in the long-duration end of the yield curve but are now going shorter duration, especially for high-yield bonds. He likes the US market and sees Greece as insolvent, whether or not it defaults on its debt.

In a comparison with hedge funds, two differences stand out. One, American Beacon Flexible Bond has to keep down overall leverage to conform to mutual fund regulation. That suggests it won’t be able to make as much money as a hedge fund pursuing the same strategy.

Mr. Hoffman says they can’t be leveraged many time over – “not like Long-Term Capital Management” – but do go short using interest rate futures. One trade that looks intriguing is to go long emerging market bonds and short developed country bonds. He said he might short the Australian dollar as China slows down and demand falls for Australia’s commodity exports. At some point even Germany may become a candidate for shorting as it bears the burden of a lot of bad European debt.

The second point of comparison is that the fee is lower—net 1.27% for investor shares, not cheap by mutual fund standards but substantially less than a hedge fund’s. A hedge fund would have to make significantly more money before fees to for its investors to get a better after-fee return. There must be bond hedge funds that do that, but there can’t be many.

In August, its first full month of operation after launch, American Beacon Flexible Bond’s investor share class made 1.43%. (Other share classes had lower returns.) Fixed income arbitrage hedge funds were down 0.96% in August, according to Barclay Hedge indexes. The mutual fund beat the hedge funds. But of course one month does not make a valid comparison and it may be beginner’s luck.

Brandywine, with $32 billion in mostly fixed income assets, is a subsidiary of Legg Mason. Of the other two advisors, GAM is well known for managing hedge fund portfolios. PIMCO runs the world’s largest bond fund—its manager, Bill Gross, was in the news in recent months for selling Treasuries and losing money when investors flocked to Treasuries for safety.

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