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Fidelity’s $100 Billion Bond King Banks on Trump Reflation Trade

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For Ford O’Neil at Fidelity Investments, the newest king of the bond world, now isn’t the time to go out on a limb. His reign is starting with more questions than answers, about the sweeping changes Donald Trump is promising and the Federal Reserve’s policy outlook.

On the one hand, he’s confident in the reflation trade that’s gripped financial markets since November. That means owning Treasury Inflation Protected Securities, or TIPS, and leveraged loans in his $25.7 billion Fidelity Total Bond Fund to protect against accelerating price growth and climbing yields. 

Yet he’s also trimmed an overweight position in corporate bonds and is staying close to his duration benchmark. Last year, bets on high-yield and energy-company debt helped his fund more than double the benchmark return, earning him and his team Morningstar Inc.’s 2016 fixed-income fund manager of the year award this week.

“We’re sitting back and trying to decide what those fiscal and regulatory changes are going to be,” said O’Neil, 54, who’s been with Boston-based Fidelity for 26 years. “It makes more sense to be conservatively positioned, knowing there’s the potential for volatility that may lead to particular sectors cheapening through the year.”

Trump’s victory in November rocked global debt markets and sent the Bloomberg Barclays U.S. Aggregate Bond index, which O’Neil’s fund tracks, to its biggest monthly loss since 2004. The president’s plans for fiscal spending have fueled bets on faster economic growth, quicker inflation and higher rates.

O’Neil’s Total Bond fund returned 5.81 percent in 2016, beating 88 percent of peers, according to data compiled by Bloomberg, which places it in the aggregate intermediate bond category. Morningstar ranked it in the fourth percentile of its competitive intermediate-term bond group. O’Neil runs the fund with Matthew Conti, Michael Foggin and Jeff Moore, and has beat the benchmark on a three-, five- and 10-year basis.

Energy Boost

O’Neil says he doesn’t see any sure-fire investments for 2017, unlike last year, when he snapped up energy-related debt. The sector returned 11.6 percent in 2016, the best since 2009, Bank of America Corp. data show.

But there are some assets he likes. For example, leveraged loans that are tied to the London Interbank Offered Rate and have a floor of 1 percent. The global benchmark eclipsed that level this month and may climb as the Fed raises rates two or three times this year, O’Neil said. That benefits the loans, which would reset to a higher coupon.

He’s also among a growing list of money managers favoring TIPS over regular Treasuries.

“There’s more pressure building in the system with regards to potential commodity inflation and also wage pressures,” O’Neil said.

Read what 2015’s bond king sees in store for this year

O’Neil said he isn’t sugarcoating the outlook to investors. Higher rates will erode gains, and high-yield bonds are “closer to peak valuations than cheap valuations,” he said.

“It’s been a wonderful tailwind of falling rates for quite a long period of time,” said O’Neil, who started at Fidelity straight out of business school and is lead manager on funds overseeing about $100 billion. “But low- to mid-single digits is the best return people should be expecting from their fixed-income portfolios today.”

As of year-end, the fund’s biggest position was in corporate debt, at about 44 percent, compared with the benchmark’s roughly 28 percent weighting. About 27 percent was in U.S. government obligations and around 16 percent in mortgage pass-through securities, both less than benchmark levels, according to data on Fidelity’s website.

Debt from financial institutions remains a “stalwart in the portfolio,” O’Neil said. That’s been the case since 2009, and bondholders have benefited as regulations like Dodd-Frank caused banks to become more like utility companies in the way they provided stable income streams to investors.

Fidelity Total Bond is up 0.29 percent in 2017, better than 77 percent of peers tracked by Bloomberg. 

“Last year almost everything in our portfolio worked, and that’s highly unusual,” he said. “Just a note of caution that there’s going to be bumps along the road.”


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