Long-term bond funds bet against inflation



If you have been holding shares in a long-term bond mutual fund while long-term interest rates have been sliding, you probably feel good about it for at least three reasons:

* Your fund's net asset value (NAV) has been rising to reflect the appreciation in the prices of bonds that the fund owns -- bonds which, on the average, mature in 10 or more years.

* Despite interest rate slippage, your fund's yield remained higher than the yields of shorter-term funds, thanks to the large gap between long- and short-term interest rates.

* Your fund's income dividend stream has held up better than that of shorter-term bond funds, thanks to the longer maturities of the bonds that haven't had to be replaced by lower-yielding issues because of maturities or calls.

Understandably, you may be tempted to add to your position.

But, watching the debate about what President Clinton and Congress might do to stimulate the economy, you also may be wondering whether inflation -- and, thus, long-term interest rates -- would rise again before long. That would cause your fund's NAV to fall. Thus, you may also be thinking of reducing your holding.

Whichever is the case, before you act on the basis of what you see and expect in the bond market, consider your own situation.

Neither you nor anyone else can be sure which way interest rates will move. But you can be sure of the risk inherent in long-term bonds and the funds that invest in them: Their prices usually fall more than those of short-term bonds when interest rates rise.

Are you willing and able to accept this risk? If you are, one of the top performers in the group that Lipper Analytical Services classifies as A-rated corporate bond funds may be for you.

A-rated corporate bond funds, as defined by Lipper, invest at least 65 percent of their assets in corporate debt issues rated in the top three of the four investment grades (AAA, AA, or A) or in government issues. (The fourth: BBB.)

Performances of the group's 65 funds differ largely on the basis of maturities, their corporate-government mix (being the safest securities, U.S. Treasury issues yield the least), their investment grade mix and their investment, if any, in "junk" bonds.

The Vanguard Group's Investment Grade Corporate Portfolio, managed by Paul G. Sullivan, senior vice president of Wellington Management, has one of the category's longest average maturities: 18.5 years. Its average quality of AA is also one of the highest.

With his fund invested over 70 percent in corporates rated A or higher, Sullivan persists in seeking securities with call protection, giving up some current yield to achieve a more sustainable interest stream. Sullivan looks, for example, for utility bonds that can't be called for 10 years and industrials that can't be called for 20 or more.

Abner D. Goldstine, president of the American Funds Group's Bond Fund of America and one of the team of eight portfolio counselors and analysts who manage it, keeps the average maturity of its corporate and government issues at nine to 10 years. The team searches for "special values" to enhance the fund's yield and return.

This includes the 20 percent of the fund's assets that is in junk bonds. "Top junk," Goldstine emphasizes. His team benefits from American's equity research in selecting bonds, he explains, and often buys bonds of firms whose stocks are held by other group funds.

John W. Geissinger, portfolio manager of Putnam Income Fund, has a similar corporate-government mix and average maturity. He's putting fresh cash into 10-year corporates: "I'm not going to fight the tide."

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