(MONEY Magazine) – It's hard to find an optimistic bond fund manager these days. With interest rates set to rise, many managers have already shifted their portfolios into low-risk short-maturity bonds. But few pros are as gloomy as the management team at FPA New Income. The fund--which over the past decade has returned an impressive 7.4% annualized--is now 37% in cash, up from 25% a year ago. In June, MONEY's Penelope Wang spoke with Tom Atteberry, who works alongside famed contrarian investor Robert Rodriguez at New Income.

Q. Why are you so bearish on bonds?

A. If you held bonds between 1998 and 2003, you outperformed stock investors. That was one of the few such five-year periods since the Great Depression. But now the great bull market in bonds has come to an end. It's time to put on your coat, get in a cab and go home--we've all had too much to drink.

Q. What's your take on interest rates?

A. Right now the Fed funds rate is at 1%, while inflation has been growing at about 3%. The Fed funds rate has rarely been less than the inflation rate. So it's reasonable to expect rates to climb to 3% over the next year and to 4.5% 18 months from now. As a result, a 10-year Treasury, which now yields about 4.75%, could yield 6% in a year or so. If you're currently holding a 10-year Treasury, therefore, you will see the principal value of your bond fall about 4%. [Bond prices fall as yields rise.]

Q. Will you start buying more bonds when Treasury yields reach 6%?

A. Probably, but yields won't necessarily stop moving up at 6%. We see a lot of inflationary pressures over the next few years. The pool of labor will shrink as baby boomers start to retire--the first wave will be leaving in 2008--and that will increase salary pressures. War in the Middle East isn't going away. Neither is the deficit, which means higher taxes down the line. And there's been no oilfield development, which will push up oil prices. I don't think we're going to see 14% inflation like we did in the '70s, but we are likely to see above-average inflation rates--between 3% and 5%.

Q. So should investors buy bonds at all?

A. Bonds still belong in investors' portfolios for long-term diversification. But you should keep your maturities as short as possible. If you cannot handle any losses, stick with cash.