Take a Chance on Loomis Sayles Bond

Except for securities issued by the U.S. Treasury, the global financial crisis has hammered just about every kind of investment, stocks and bonds alike. One of the best bond funds, Loomis Sayles Bond (symbol LSBRX), lost 27% year-to-date through October 24 -- an almost unimaginable decline for a fund that mainly buys investment-grade debt.

In my mind, Loomis Sayles Bond, a member of the Kiplinger 25, represents a classic buying opportunity. If you don't own a stake in the fund, now is the time to buy. If you are already invested in it, consider adding to your shrunken stake. "If you're a smart investor and you have cash, these markets are as cheap as they've ever been," says co-manager Kathleen Gaffney. "Bonds are a lot cheaper than stocks. I have a hard time thinking there's anything else this cheap." Over the next couple of years, she says, corporate bonds could return a total of 30% to 40%.

Dan Fuss, age 75, the fund's lead manager, has never seen a bloodbath of this magnitude in his half century as a bond investor. Neither has Gaffney. "This has never happened in my lifetime," she says. "The only thing people want is cash. That's an end-of-the-world type of craziness. Unless you think this is the end of the world, the fund will be in a great position when we get to the recovery stage."

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Loomis Sayles Bond has always been riskier than the typical bond fund. Since starting the fund in 1991 (and signing on Gaffney as co-manager in 1997), Fuss has liked risky bonds. He's typically had as much as one-third of the fund's assets in high-risk junk bonds. He's also been partial to foreign bonds, including those from fast-growing but volatile emerging markets. (Fuss started Loomis Sayles Bond Institutional (LSBDX) in 1991; Loomis Sayles Bond Retail was launched in 1997. The only differences between the two are that the institutional class requires a minimum investment of $100,000 and charges annual expenses of 0.67%, while Retail requires only $2,500 to start and charges 0.97% a year.)

Until this year, however, the managers' risk-taking has been amply rewarded. From its inception in 1991 through Sepmber 30, Loomis Sayles Bond returned 9.7% annualized -- an average of three percentage points per year better than the Lehman Aggregate Bond index. Over the past ten years through September 30, the fund returned an annualized 7.6%, putting it in the top 12% among multi-sector bond funds, according to Morningstar. Until 2008, the fund's biggest loss in any calendar year was 4%, in 1994.

What went wrong this year? Everything. Loomis had too much in investment-grade corporate bonds and junk bonds, and too much in foreign bonds, especially emerging-markets bonds. And it had almost nothing in Treasuries. Through October 24, investment-grade bonds have dropped 14% so far this year, while junk bonds have plunged 26%. Lately, Gaffney says, "Investment-grade corporates have been hit the hardest of all. It has been painful getting to this point. We didn't expect these spectacular events."

The fund's current yield is nearly 10%, a compelling figure. It currently has 45% of its assets in investment-grade corporates, 23% in junk, 28% in foreign bonds and 4% in cash. Gaffney says that, so far, shareholders haven't been pulling money from the $14.5-billion fund.

Gaffney is pleased by the federal government's actions thus far to resolve the financial crisis. "You needed to get capital into the banks; the markets wanted to see that." She sees signs that frozen credit markets are starting to thaw.

The next question: How long and deep will be the recession be? The markets reflect fear of a severe and lengthy recession, but Gaffney says she doesn't think the downturn will be as bad as many expect.

She thinks leadership from Washington will continue to be crucial to resolve the economy's problems. "It matters who the next Treasury secretary is." What's more, she says, it's important that authorities do what's necessary "to keep people in their homes." That will require measures to stop foreclosures -- except for borrowers who wouldn't be able to pay even reduced mortgage payments.

Steven T. Goldberg (bio) is an investment adviser and freelance writer.