Morgan Stanley Investment Management’s Vishal Khanduja, a top-performing bond investor, is turning bullish on US debt for the first time in a decade, with yields at two-decade highs serving as a check on economic growth.
The $4.1 billion Eaton Vance Total Return Bond Fund, which Khanduja co-manages with Brian Ellis, boosted its duration — a measure of interest-rate risk — to 6.07 years as of June, above 5.8 years for the benchmark Bloomberg US Aggregate Bond Index. It marks the fund’s first duration overweight in more than a decade, said Khanduja, head of the broad markets fixed-income team.
He spoke in an interview this week after a bruising stretch for the bond market, as elevated energy prices, a resilient economy and massive government borrowing have collided with a surge in corporate borrowing to finance artificial-intelligence investment. The array of forces has pushed yields on 10-year notes up roughly a percentage point since June, to a fresh 24-year high of 5.36% on Wednesday.
While the selloff may still “overshoot” by another 10 to 15 basis points, Khanduja said the lofty yields give investors enough income to cushion against further price declines. At the same time, higher borrowing costs are beginning to strain weaker parts of the global economy, such as lower-income consumers, leveraged companies and indebted governments.
“We are pacing ourselves in terms of the magnitude of bets that we are taking,” said Khanduja, who started his Wall Street career in 2005. They are “slowly but steadily” taking advantage of “these overshoots to add some yield exposure to the portfolio,” he said. “My conviction 12 months out is very, very high.”
Khanduja’s fund has returned 2.9% annually over the past decade, more than double the Bloomberg benchmark, and has beat 97% of its Morningstar peers in that period.
This year, it’s been punished along with the rest of the fixed-income world as the Iran war triggered a surge in energy prices that has fanned inflation concerns. The fund has lost about 2.8% this year, putting it in the middle of the pack, and in line with the decline in the benchmark index.
The money manager says the combination of higher yields, tightening financial conditions and a more hawkish Federal Reserve has tilted the risk-reward equation in favor of adding duration.
One reason for his confidence stems from his view on the Fed, which raised interest rates last month for the first time in three years and signaled more increases are coming.
The Fed, he says, is a “big bond vigilante ” whose determination to curb inflation will eventually slow growth and put a ceiling on yields. He says tighter financial conditions are already showing up in widening spreads for lower-rated companies and some sovereign borrowers, such as France.
Part of his bullishness comes down to bond math. Investors buying 10-year Treasuries at current levels would need yields to rise to around 6% over the next year before price losses wipe out their income, according to data compiled by Bloomberg.
“The valuation side has started to look extremely attractive,” he said. “Where we are squinting our eyes for is a catalyst for a rally in yields.”