it has been a tough few years for bond bears, but this fall<u+2019>s interest-rate rise is vindicating a handful of investors who have been waiting for just such a move. fund managers at franklin resources inc., pacific investment management co. and goldman sachs group inc. began taking steps earlier this year to hedge against rising rates, even before donald trump <u+2019>s nov. 8<u+00a0>electoral victory spurred the sharpest bond selloff in years . some purchased derivatives benefiting from rising rates. others bet that prices of treasury notes would fall. bond yields move inversely to prices. all shared a conviction that u.s. interest rates couldn<u+2019>t stay as low as they were in the summer, when the 10-year treasury had its lowest-ever closing yield. instead they thought the world<u+2019>s largest economy was due to gather steam, spurring a long-awaited pickup in inflation . while most of the funds continue to lag behind benchmarks, the bets have sheltered the funds from the recent bond-market losses, narrowing the performance gap and stoking optimism about further gains. <u+201c>to us, october was a watershed month,<u+201d> said michael hasenstab, portfolio manager of franklin templeton<u+2019>s $42 billion global bond fund. pointing to data showing rising core inflation and wages, he said, <u+201c>there was a realization that economic growth was not as bad as some had predicted and that inflationary risk was rising.<u+201d> mr. hasenstab<u+2019>s fund has gained about 1% since september, according to data from research firm morningstar inc. over the same stretch, the bloomberg barclays global aggregate bond index has lost about 5%. the franklin fund isn<u+2019>t alone. other gainers include the $9 billion goldman sachs strategic income fund co-managed by portfolio manager mike swell and the $68 billion pimco income fund co-managed by pimco chief investment officer dan ivascyn. the upturn in u.s. rates is being supported in part by market wagers that mr. trump<u+2019>s plan for tax cuts, infrastructure spending and deregulation will spur increases in growth and inflation. though the 10-year treasury yield recently topped 2.3% for the first time this year, many skeptics have said they think selling could continue, driving yields still higher. <u+201c>it<u+2019>s going to require a little more of a selloff<u+201d> for the pimco income fund to start meaningfully adding to treasury holdings again, said mr. ivascyn. the prospect of cooperation between mr. trump and the republican-controlled congress on stimulative economic policy indicates that rates are still more likely to rise than to fall from recent levels, he said. on thursday, the yield on the 10-year note rose to 2.278%, its highest closing level since december. to be sure, many investors are skeptical that growth and inflation will climb meaningfully soon or even that higher rates will persist for long. low rates are driven in large measure by long-running factors that aren<u+2019>t amenable to policy fixes, such as soft growth, rising debt and aging populations, these skeptics contend. even so, the yield reversal has been timely for franklin templeton<u+2019>s mr. hasenstab. his fund trailed most competitors for the first two-thirds of the year, hurting performance until september<u+2019>s turnabout. his gains would have been greater were it not for losses from mr. hasenstab<u+2019>s bet on the mexican peso, which has fallen about 9% against the u.s. dollar since mr. trump<u+2019>s election. but, mr. hasenstab said, <u+201c>this is only the beginning of the adjustment in higher rates,<u+201d> and he has no plans to trim his bearish bets. rising rates typically punish bond funds, but portfolio managers can reduce their interest-rate sensitivity, or <u+201c>duration,<u+201d> by buying more short-term bonds, buying derivatives that rise in value with rates or betting against government bonds. interest rates have been falling since 2014, an environment that favored index funds, which aim to match the returns from an index or asset class, in this case bonds. the largest such fund, the $175 billion vanguard total bond market index fund, returned 6% through the end of august, while funds that bet rates would rise delivered mostly flat returns during that period. since then, the tables have turned. the vanguard fund has lost about 3% since the start of september, wiping out half of the year<u+2019>s gains. the fund still has a gain of 2.8% year to date, compared with a return of about 0.5% for mr. hasenstab<u+2019>s fund, according to morningstar. <u+201c>it shows that investors should have a balanced portfolio,<u+201d> said mr. swell of the goldman sachs strategic income fund, which seeks to reduce rate sensitivity by buying up some government and corporate bonds and betting against others. as mr. swell became convinced this year that inflation was poised to rise, he pushed duration in the fund below zero by buying swap contracts that would increase in price if u.s. interest rates rose, offsetting that with a bet that rates in canada would remain low. pimco income fund cut its duration by about 28% in the first six months of 2016, giving it an effective buffer when the bond selloff began. mr. ivascyn said he bought australian, brazilian and mexican bonds to offset the reduced holdings of treasurys. the fund has gained 0.8% since sept. 1, boosting its year-to-date performance to 6.9%, according to morningstar data. write to matt wirz at matthieu.wirz@wsj.com and sam goldfarb at sam.goldfarb@wsj.com
10-year treasury yield<u+2019>s surge vindicates bond bears - wsj
matt wirz sam goldfarb