Bonds on steroids
Scouring the globe for undervalued debt, star fixed-income fund manager Dan Fuss has topped the stock market over the past 15 years.
By David Stires, Fortune writer

(Fortune Magazine) -- Take a look at Dan Fuss's investment returns, and you'd think he was a pretty good stock picker. Check that - a great stock picker.

During the 15 years he's been managing the flagship mutual fund at Loomis Sayles & Co., an 80-year-old investment firm based in Boston, he's returned 11.3% a year (annualized). Not only has he surpassed the S&P 500 - with less volatility - he's also outgunned most equity fund managers.

Dan Fuss bets on everything from Philippine telephone bonds to the New Zealand dollar.

But here's the kicker: Fuss doesn't run a stock fund. He's a bond investor, and he's arguably the best one on the planet.

His numbers at Loomis Sayles Bond (Charts) say it all. Fuss sports the top record of any fixed-income manager over 15 years, nearly doubling his competitors' average yearly return.

During that time he's bested his much-better-known rival Bill Gross, who runs Pimco Total Return (Charts) the world's largest bond fund, with $93 billion in assets. Fuss's stellar showing since his May 1991 start at Loomis Sayles Bond easily beats Gross's 8% return at Pimco Total Return for the same stretch.

And along with Kathleen Gaffney, who has been his co-manager at the fund since 1997, he's been superb over shorter periods, outperforming at least 95% of other diversified bond funds over three, five, and ten years, with annualized gains around 10%.

Speak softly

So why haven't you heard of him? Unlike Gross, Fuss shies away from making bold, headline-grabbing pronouncements on the economy and politics. A Wisconsin native who sprinkles conversations with self-deprecating jokes, Fuss tends to avoid the spotlight.

The former Navy officer keeps a strict daily routine, rising each morning at 4:23 to begin the day's research by watching the financial news and reading the papers over a bowl of Wheaties at his kitchen table.

He's at his desk at Loomis's Boston headquarters by 7, often placing trades before many people get out of bed. It's a game that Fuss, who turns 73 in September, obviously relishes. Asked if he has any plans to retire, he shoots back, "Never!"

Clearly, Fuss is worth listening to. He has a rare ability to read and profit from subtle shifts in the global landscape. And right now is a particularly delicate time for bond investors.

In the U.S. the economy is slowing, prompting speculation that the Federal Reserve may finally end its long rate-hike campaign. But central banks around the globe are still tightening - historically a bad omen for investors.

You may recall that the stock market crash of 1987, the bursting of the Japanese real estate bubble in the early 1990s, and the Asian financial crisis of 1997 all occurred when central banks were raising interest rates.

Reading the tea leaves

Speaking by phone from his office on the 34th floor, Fuss paints a gloomy economic picture, especially for the U.S. He points out that economic growth is slowing just as prices are rising - a miserable mixture that could lead to an era of stagflation reminiscent of the 1970s.

He says the federal government has promised "the old folks" health and retirement benefits that it can't deliver without hiking taxes or cutting spending, yet it shows little inclination to do either.

Instead, he expects federal borrowing to grow, sending the yield on the ten-year Treasury, now 5%, to 6.25% over the next few years. That's bad news for Treasurys, because rising rates cause prices to fall.

What sets Fuss apart as a bond manager is good, old-fashioned security selection. Fuss, who manages several fixed-income funds at Loomis that collectively have about a quarter of the firm's $82 billion in assets, is a deep-value investor.

He looks to scoop up bonds that seem cheap compared with historical averages and with the strength of the issuer, whether it's a company or a government. And he has a hedge fund manager's eye for opportunity, often placing big bets on asset classes like junk bonds, emerging-market debt, and foreign currencies.

To wit: His favorite play right now is the New Zealand dollar. "It's the best story out there," he says, arguing that the country's booming economy will drive up the currency.

Not surprisingly, Fuss isn't lending much to Uncle Sam. Corporate bonds account for most of his domestic holdings (which represent 60% of the fund's assets), in part because he expects economic growth and profits to stay relatively strong through 2007.

But Fuss isn't one to seek shelter in AAA-rated fare. What he looks for is much harder to find - bonds with above-average yields, low default risks, and the potential for sharp price gains, primarily through credit upgrades. "We want to have our cake and to eat it too," he says.

The leveraged-buyout boom is providing Fuss with some attractive opportunities. Buyout firms typically fund their deals - and extract their fees - by having the company they acquire issue new debt.

Prices of the company's existing bonds will often fall in response, leading to good bargain hunting, says Fuss. The trick is to find strong managers who are committed for the long haul. "In a lot of the LBO situations, the owners are going to be there only a few years and then try to take their money out of it," he says.


Fuss recently purchased the bonds of Georgia Pacific, the building- products and paper giant that was acquired by privately held Koch Industries for $13 billion in December.

The company's 7.75% bonds due 2029 yield 8.7% and are rated just below investment grade. But Fuss sees the potential for operating improvements and believes Koch's managers have "very high integrity" and are committed for the long run. "It's not likely they're going to flip it," he says.

Fuss has 40% of the fund's assets in foreign issues, but that's not as daring as it may seem. Half of that amount is stashed in Canadian government notes.

Fuss started buying a variety of Canadian debt about eight years ago because he believed the nation's economic growth and the government's commitment to fiscal discipline would lead to higher credit ratings and a stronger currency. Today most of the credit improvement has taken place, but he thinks that the currency will continue to rally.

A riskier yet potentially more rewarding play is Philippine Long Distance Telephone (Charts). The company's 8.35% bonds due 2017 yield 7.4% and are rated just below investment grade.

But Fuss believes management is doing the right things to get them upgraded by increasing earnings and paying down debt. Plus the company has a duopoly on the Philippine telephone business. "They have their problems, but making money isn't one of them," says Fuss.

If these ideas sound intriguing but you don't feel up to valuing exotic issues on your own, you can always invest in Fuss's fund. Ron Rogé, a financial planner in Bohemia, N.Y., recommends it as the core bond fund for many of his clients.

Fuss's flexible approach, he says, provides exposure to everything from high-yield to foreign bonds. Morningstar analyst Paul Herbert says you can also use the fund as a supporting player. One option is to pair it with a low-cost index fund such as Vanguard Total Bond Market Index (Charts) or Fidelity U.S. Bond Index .Herbert (Charts) says Fuss's fund can be volatile, and his large stakes in riskier fare can be a liability at times, such as 1998, when the credit markets turned south. But over time the risks pay off, as his outstanding results clearly show.


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