NEW YORK, March 15 (Reuters) - Managers of top-performing “unconstrained” bond funds have slashed their stakes in U.S. corporate bonds following a monstrous rally, reflecting skepticism that any tax changes enacted under President Donald Trump can drive prices even higher.
Wealth management firms Guggenheim, Pioneer and TCW, which have beaten at least 96 percent of their peers in Morningstar’s non-traditional bond category over five years, said those bond prices also appeared stretched because the U.S. Federal Reserve looks poised to raise interest rates multiple times.
Unconstrained bond fund managers can make big bets on a wide array of assets because they are not tethered to a benchmark index.
Their moves are worth following because they can be more objective than stewards of plain-vanilla corporate bond funds, which must hold a high percentage of the asset category regardless of market conditions, said Todd Rosenbluth, director of ETF & mutual fund research at CFRA Research.
Optimism about Trump’s avowed policies, which include a pledge to slash tax rates on businesses and let companies bring overseas profits into the country at a low rate, has helped drive up corporate bond prices.
The Bloomberg Barclays U.S. Corporate High Yield Index has fallen 1.6 percent this month but is still up 1.3 percent for 2017 after surging 17 percent last year, while the index tracking investment-grade bonds is down 0.3 percent this year after gaining 6.1 percent in 2016.
Stephen Kane, co-manager of the $3.4 billion Metropolitan West Unconstrained Bond Fund, said yields on junk bonds could widen by up to 5 percent against Treasuries over the next one or two years, which would equate to a roughly 10 percent loss.
Kane said he favored non-agency mortgage-backed securities. Their underlying loans are not backed by the U.S. government.
The fund has chopped its corporate bond allocation to 28 percent, which Kane called conservative, and its 4 percent exposure to junk bonds is near its lowest ever.
“One way or the other, we think that the U.S. economy is due for a significant slowdown in growth and a deleveraging where credit performs poorly,” he said.
Demand for unconstrained funds has rebounded this year.
Morningstar said investors poured $2.6 billion into the U.S. non-traditional bond fund category in the first two months of 2017 after withdrawing more than $34 billion from the funds over the past two years combined.
The $4.8 billion Guggenheim Macro Opportunities Fund last had record-low holdings of 5 percent for junk bonds and about 1 percent for investment-grade corporate debt, co-manager Steven Brown said.
Brown said the fund preferred commercial and corporate asset-backed securities as well as non-agency residential mortgage-backed securities since those asset classes were still cheap.
Trump has pledged to cut the corporate tax rate to 15 percent from 35 percent and has called for a 10 percent rate for repatriated overseas profits held in cash, payable over a decade. He has also called for an elimination of the tax deductibility of interest payments for corporations.
Some investors have said that a reduced tax rate would prompt companies with cash abroad to bring that money back into the United States and use it toward capital expenditures, thereby boosting corporate earnings.
They have also said a greater amount of cash held in the United States would cause companies to issue fewer bonds, pushing up prices by reducing supply.
The top unconstrained fund managers doubted that scenario.
Cash repatriation would probably not lead to significantly higher corporate bond prices since companies with large amounts of money overseas, such as Apple Inc and Alphabet Inc , already have strong credit ratings, said Michael Temple, co-manager of the $271 million Pioneer Dynamic Credit Fund.
Since they can issue bonds at reasonably low interest rates, these companies would feel no pressure to use any repatriated cash to repurchase their own debt, he said. As a result, prices would not benefit from a reduction in supply.
Most high-yield companies do not have much cash overseas and would probably be unaffected, Temple added.
Temple said his fund had cut its stake in corporate bonds and junk exposure while increasing its position in insurance-linked assets such as catastrophe bonds and reinsurance sidecars.
Brown of Guggenheim said the potential outcome of Trump’s tax promises was unclear and did not warrant making bigger bets on corporate bonds.
“We assign a relatively high discount rate to the proposed changes,” Brown said. “We just don’t think you’re getting fairly compensated right now for the unknowns.”
Reporting by Sam Forgione; Editing by Jennifer Ablan and Lisa Von Ahn