Robert Rodriguez

FPA New Income Fund

by Marla Brill
MFI Publisher

Taming The Interest Rate Beast

Bonds are like that wolf in sheep’s clothing—a seemingly benign investment whose teeth can come out with frightening ferocity when interest rates rise.  Since the 1970s, when yields on long-term issues soared to almost 20 percent and sent bond prices into a freefall, many investors have had to learn that lesson through painful, often unexpected losses.

But shareholders of FPA New Income Fund have witnessed a more benign version of the interest rate beast. Since its inception in 1969, the fund has not had a single calendar year of negative returns. Robert Rodriguez, its manager since 1984, attributes the steady course of the fund during his tenure to a healthy fear of what the bond market can do.

As a young portfolio manager for private accounts in the 1970s and early 1980s, he saw interest rate swings devour wealth for bondholders. When he took over New Income in 1984, he vowed to try to minimize bond losses because, in some ways, they are more caustic and lasting than losses from stocks.

“Stocks are much more heterogeneous than bonds,” he says. “Some stocks can hit new highs, even if the broader markets are hitting new lows. But if the bond market is in a slump, you’ll find few if any bonds that are doing well. So if you are wrong and interest rates move against you, there aren’t as many ways to dig yourself out of the problem.”

Rodriguez tries to minimize interest rate swings by investing in an eclectic group of fixed-income securities whose ups and downs offset each other. Using a “credit barbell” approach, he often mixes high-quality government or mortgage-backed bonds with carefully-evaluated high-yielding junk bonds and busted convertibles, which are less sensitive to interest rate fluctuations. The fund’s duration is rarely longer than that of its benchmark, the Lehman Brothers Government/Credit Index. Right now, FPA New Income fund’s duration stands at a conservative 2.2 years, well under the 5.2-year duration of its benchmark.

Since 1997, Rodriguez has also made liberal use of Treasury Inflation Protection Securities (TIPS) to enhance performance and moderate volatility. The bonds, which currently make up 31 percent of the portfolio and about half his allocation toward government securities, have out-performed ten-year Treasury bonds since the fund began buying them. According to a study done by Tom Atteberry, an analyst who works with Rodriguez, the fund’s TIPS produced an annualized return of 8.1 percent between June 30, 1997 and September 30, 2001, compared to 6.9 percent for 10 year comparative nominal Treasury bond. They were also less volatile over the period.

Over the long-term, Rodriguez’s attention to moderating volatility has helped produce an exceptional long-term record. As of February 18, the fund’s performance has landed it in the top 5 percent of its group over the last one, three, five, and ten-year periods. In its worst quarter, which occurred in 1987, it lost just 0.9 percent of its value, compared to 2.91 percent for the Lehman Index.  In 2001, its 12.3 percent gain, compared to a return of 7.3 percent for the average fund in the group, prompted Morningstar to name Rodriguez its fixed-income manager of the year.

But there have been times, such as 1997 and 1998, when managers willing to make bolder interest rate bets by extending their funds’ durations came out ahead as rates fell. In those two years, FPA New Income finished in the bottom half of its peer group. 

“We can’t call every market cycle, and we don’t think the rewards are high enough to risk being wrong,” says Rodriguez.  “To minimize losses you have to be willing to lag for short periods.”

He also acknowledges that some managers are better in bullish bond markets than he is. “Bill Gross at PIMCO is good at capturing the upside on bonds when interest rates are falling,” he says. “Our relative strength shows when the bond market is neutral or down.”

Next: Preparing For A Subdued Recovery