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Special Report

Behind Loomis Sayles Bond's Gold Rating

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The following is an excerpt from Morningstar's Premium Analyst Report for  Loomis Sayles Bond (LSBDX), a multisector bond fund that receives a Gold Morningstar Analyst Rating. Premium Members can  click here to see the full Analyst Report. Not a Premium Member? Take a free Premium trial to gain access to this and hundreds more reports.

Process Pillar: Positive | 01/30/2014
As the flagship in the Loomis Sayles lineup, this fund has built a strong reputation with its corporate-heavy, often deep-value approach to investing in the bond markets. Manager Dan Fuss and his team enjoy some flexibility: They can invest up to 35% of the portfolio in below-investment-grade names and another 20% in equities (with a 10% limit on common stock). The team is active outside the United States as well: It can invest up to 20% of the portfolio in foreign issuers, with no limit on Canadian issuers. While bottom-up credit research plays a significant role here, so do the firm's views on broad economic trends and interest rates.

Not surprisingly, there's a strong contrarian bent at work here. In 2009, for example, the fund increased its stake in Ford debt at a time when many predicted bankruptcy; in late 2011, the fund found opportunities in European corporates amid fears of a potential breakup of the eurozone. It has also invested in troubled European sovereigns, most notably Ireland. Such level-headedness when credit markets swoon help explain the fund's stellar long-term returns, although a penchant for credit and currency risk makes it vulnerable in flights to quality.

Under the leadership of chief investment officer Jae Park, the team has significantly built out its tools and staff dedicated to risk management, and these are integrated into the day-to-day management of the fund.

The team's expectations of slow growth and low but eventually rising interest rates lie behind a sizable stake in a mix of dividend-paying equities, preferreds, and convertibles (20% recently). Comanager Elaine Stokes argues that these offer good upside if growth picks up and rates rise. At the same time, the fund is treading carefully in high-yield bonds (21%), a sector that the team views as richly priced. Although large in absolute terms, the fund's junk stake lands near the low end of its 10-year range. Its position in dollar-denominated investment-grade domestic corporates (16%) has fallen considerably since its peak late during and immediately after 2008.

The fund is also adventurous when it comes to currency risk: Exposure to non-U.S. and Canadian dollar-denominated currency recently totaled 21%. So, while the portfolio is anchored by a 23% stake in a mix of high-quality sovereigns--Canada is a particular favorite--and other AAA debt, this portfolio's heady mix of corporate and currency exposure gives it plenty of giddy-up.

The team, which historically favored long, call-protected bonds, has increasingly become more cautious when it comes to interest-rate risk. Stokes notes that while the fund's reported duration recently stood at 5.1 years, the team believes that it has limited exposure to changes in Treasury yields, an observation borne out by the fund's performance in 2013.

Performance Pillar: Positive | 01/30/2014
This portfolio's bargain-hunting, corporate-heavy strategy shines in strong credit and equity markets. As corporate bonds rebounded sharply from the depths of the credit crisis in 2009, the fund gained an impressive 37%, thanks to its patience with struggling names such as Ford and level-headed bargain-hunting among stalwarts like AT&T T. The fund turned in a similar, if less dramatic, performance in 2012, thanks in part to its position in Irish sovereign debt. And it managed to hold up well in 2013's bumpy bond markets, buoyed by its stake in common stock and convertibles. Such campaigns have helped fuel an impressive long-term record: The fund's 8% 10-year annualized return trails just a handful of funds in the multisector bond category, three of which are sibling portfolios.

Those heady returns haven't come without risk, however. Hefty doses of credit risk as well as significant nondollar currency exposure--and investments in the occasional troubled sovereign--can make for a volatile ride. The fund lost 22% in 2008's rocky credit markets, landing it behind 85% of peers; more recently, it lost 5% in the third quarter of 2011. Meanwhile, the fund's recent focus on equities and equity-sensitive convertibles leave it more vulnerable to a stock market sell-off than it has been in the past. That's not to detract from the team's exceptional record of uncovering value in the bond markets, but this fund requires patience.

People Pillar: Positive | 01/30/2014
Kathleen Gaffney's 2012 departure came as a surprise to many external observers who viewed her as longtime manager Dan Fuss' eventual successor. However, the success of this fund and the Loomis Sayles fixed-income lineup had depended on more than one or two individuals for some time, and Gaffney left behind a strong team. Fuss, who pioneered the fund's unique benchmark-agnostic approach, remains actively involved and has no immediate plans to retire. He works closely with Matthew Eagan and Elaine Stokes, both Loomis Sayles veterans who have comanaged this fund since 2007. A 40-plus person credit team, as well as dedicated sovereign and macro researchers, supports the portfolio managers.

Under CIO Jae Park, Loomis Sayles has also invested significantly in the resources backing this group, including the expansion of the firm's risk-management, securitized asset research, and macroeconomic research capabilities. Park has also established a committee structure to help fuel its fixed-income teams' macroeconomic views, asset allocation, and yield curve positioning. Working together with the portfolio managers, senior-level strategists assigned to each fund share responsibility for funneling investment ideas into the portfolio.

Fuss and Stokes both invest more than $1 million here; Eagan invests more than $500,000.

Parent Pillar: Positive | 07/18/2013
Paris-based Natixis Global Asset Management is the parent to Boston-based Loomis Sayles and a handful of other asset managers, including the Gateway and ASG funds, with Loomis representing the majority of the firm's $90 billion in U.S. fund assets.

Loomis Sayles' reputation has largely been forged by the firm's well-regarded fixed-income operation and its vice-chairman, Dan Fuss, who has capably led Loomis Sayles Bond the past 20 years. The firm also offers a small array of equity funds. The stock funds don't get the same attention as their bond cousins, but the teams behind funds like  Loomis Sayles Value (LSVRX) have quietly built decent records.

The firm is preparing for a post-Fuss era. It has expanded the role of Jae Park, the firm's fixed-income CIO, to oversee all of Loomis' investment teams. Park had already built out resources to support the firm's fixed-income managers. The departure of Fuss' comanager Kathleen Gaffney for Eaton Vance in late 2012 was a setback, but the people and systems Park had put in place have helped the team weather that loss.

Loomis Sayles aims to keep its professionals in place with a sensible compensation plan that emphasizes long-term performance. The tactic has worked: A majority of the firm's lineup is run by managers with 15-plus years of experience. In addition, the funds are overseen by a board that invests alongside shareholders.

Price Pillar: Positive | 01/30/2014
At 63 basis points, expenses on this fund's institutional shares (60% of assets) rank as Below Average relative to similarly structured share classes; the group's median expense ratio stands at 75 basis points.

Expenses on the fund's no-load, retail shares (38%) are less competitive. At 92 basis points, they are a touch higher than the 91-basis-point median expense ratio for no-load share classes.

Sarah Bush does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.