A prominent US Treasury bull has reversed its long-standing position after more than thirty years.
Hoisington Investment Management Co., renowned for its persistent bullish outlook on US Treasuries, has fundamentally altered an investment stance maintained for over three decades. Regulatory filings indicate the firm is significantly reducing the sensitivity of its bond portfolio to changes in long-term interest rates.
By the end of September last year, the effective duration of assets held by Hoisington's fund was as high as 20.88 years. Effective duration measures a bond's price sensitivity to yield changes; a higher number means interest rate fluctuations have a greater impact on the portfolio's value.
By the end of March this year, the fund's effective duration had dropped to 4.7 years; as of June 30, this metric had further shortened to less than one year. In contrast, the duration of its benchmark Bloomberg US Aggregate Bond Index is approximately 6 years.
Shifting Long-Term Rate Outlook Due to Deficits and Capital Needs
In its latest quarterly report, Hoisington Investment Management stated that expanding fiscal deficits and increasing capital requirements form a "broader structural backdrop," which "suggests both inflation and long-term Treasury yields will trend higher."
The report, co-authored by founder Van R. Hoisington and chief economist Lacy Hunt, presents a new judgment that breaks with the firm's decades-long bullish stance on US Treasuries.
Fixed-income investors are currently widely concerned that future inflation may not only persist at higher levels but also become more volatile. Inflation erodes the real return on bonds and keeps interest rates elevated for longer.
Continuously expanding debt levels are another risk highlighted by Hoisington. The report argues this is prompting investors to "increasingly demand higher risk premiums on US Treasuries." Higher required risk compensation implies the future interest rate environment may be "less stable than the period from 1990 to 2020."
During the prior 30 years, US Treasury yields consistently declined, fueling a prolonged bull market in bonds.
Van R. Hoisington wrote in the report that the "long-run equilibrium range for inflation is migrating upward," potentially settling between 3.5% and 4.5%, "with a significant risk of the inflation rate temporarily exceeding 5%."
Hoisington began adjusting its investment strategy in the first quarter of this year. The US-Iran conflict that flared up in late February pushed oil prices higher, further increasing inflationary pressures and market inflation expectations.
As the Federal Reserve signaled expectations for interest rate hikes, US Treasury yields climbed. Influenced by rising oil prices, the yield on the 30-year US Treasury approached 5.2% in May, its highest level since 2007, and was hovering around 5.12% on Thursday.
Long-Duration Strategy Faces Post-Pandemic Interest Rate Headwinds
Hoisington's shift to a bearish view may also be seen by the market as a relatively late adjustment. During the 2020 pandemic, the yield on the 30-year US Treasury fell to a historic low of less than 2%, and the general trend since then has been one of volatile ascent.
During this period, bond market rallies occurred intermittently but only temporarily halted the rise in yields. Return data has also been under pressure, with a global government debt benchmark index still down 19% from its 2020 peak.
Throughout the long US Treasury bull market and in the years following the pandemic, Hoisington concentrated client funds in long-duration bonds and zero-coupon bonds. The Wasatch-Hoisington Treasury Fund is one product employing this strategy.
This allocation aimed to profit from falling yields. When bond yields decline, long-duration and zero-coupon bonds typically experience more pronounced price increases due to their higher interest rate sensitivity.
This strategy also allowed Hoisington's fund to outperform during bond market rallies but significantly lag during sell-offs. Although the overall decline in long-term yields once delivered substantial returns, the fund's average annualized return since inception remained at 5.38% as of June 30.
Performance over the past five years has deteriorated markedly, with the fund posting an annualized loss of 8.7%. Its assets under management have also declined from approximately $5 billion in 2020 to less than $2 billion last year.
Expanding US capital expenditures are further adding upward pressure on Treasury yields. The US and other governments need to fund widening fiscal deficits, while companies are increasing borrowing for investments in artificial intelligence.
Simultaneous increases in government financing needs and corporate bond issuance are boosting supply in the bond market. Without a commensurate expansion in demand, higher bond supply typically requires higher yields to attract investors.
DoubleLine Capital CEO Jeffrey Gundlach, known as the "new bond king," stated in a post this Tuesday that the 30-year US Treasury yield is "continuing to test resistance just above 5%," a level that "seems unlikely to hold." He subsequently added, "It is commendable that even Lacy Hunt has turned bearish."
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