Higher return on bonds naturally lures money

Andrew Leckey

May 26, 1993|By Andrew Leckey | Andrew Leckey,Tribune Media Services

It's easy to explain the flood of investor money into bond funds.

After all, three-month bank certificates of deposit yielded about 5.5 percent in the fall of 1991. These days, yields are stuck at around 2.5 percent.

This dramatic drop in return dictates new strategies, so the higher yields of tax-free and taxable bond funds have lured considerable investor money.

If an investor realizes that the value of bond funds can fluctuate on interest rate movement, and that factors such as duration of the underlying bonds and credit risk also play a role, he'll likely be rewarded.

In tax-free bonds, there's an added incentive from the Clinton administration.

"Since the election, demand for municipals has accelerated because individuals know they'll be facing higher income taxes," explains Pamela Hunter, portfolio manager of Vista Tax-Free Income Fund, up 19.01 percent in total return the last 12 months with a bond portfolio averaging a maturity of 16 1/2 years and a credit rating of AA.

"At the same time, the tax-exempt bond market in the past several months has become very cheap relative to Treasuries because we've had so much supply."

Accepting risk has been a shrewd idea in recent times.

"It's been a bull market for bonds, and the top-performing funds have done incredibly well because they have very long duration bonds in them," explains John Rekenthaler, editor of the Morningstar Mutual Funds investment advisory. "However, if we had a bear market, the reverse would have applied, since long durations make funds more sensitive to interest rates."

Top national tax-free bond funds in total return the last 12 months, according to Morningstar, were:

* Vista Tax-Free Income Fund, Kansas City, Mo.; $38 million assets; 4.5 percent "load" (initial sales charge); $1,000 minimum initial investment; up 19.01 percent.

* Shearson Lehman Brothers Managed Municipals "A," New York; $1.69 billion assets; 4.5 percent load; $1,000 minimum, up 16.86 percent.

* Strong Insured Municipal Bond Fund, Menomonee Falls, Wis.; $46 million assets; no load; $2,500 minimum; up 16.85 percent.

* Benham National Tax Free Long Term Fund, Mountain View, Calif.; $56 million assets; no load; $2,500 minimum; up 15.97 percent.

George Friedlander, fixed-income strategist with Smith Barney, Harris Upham & Co., warns of a coming shortage of municipals.

"We're eventually going to run out of supply because the current volume of debt refunding won't continue unless interest rates keep coming down," explains Friedlander, who expects a modest decline in short- and long-term rates this year. "When supply abates, it'll be harder for individuals to find appropriate bonds without bidding up prices, and this will also provide price support for existing issues."

In taxables, the leaders in return have been zero-coupon bond funds, whose prices swing sharply in response to interest rate changes. Convertible bond funds, featuring securities that provide the option to convert to stock, also have excelled.

"People who buy a convertible bond fund must be people who can take some kind of risk," warns William Hensel, portfolio manager of Pacific Horizon Capital Income Fund, up 26.54 percent in the last 12 months. "I'd say our convertible fund probably has less risk than a stock fund, but more than a straight bond fund."

Top taxable bond funds over 12 months were:

* Benham Target Maturities Trust 2010 Portfolio, Mountain View, Calif.; $44 million in assets; no load; $2,500 minimum initial investment; up 28.36 percent.

* Alliance Corporate Bond Fund "A" Shares, Secaucus, N.J.; $203 million in assets; 3 percent load; $250 minimum; up 28.32 percent.

* Rochester Convertible Fund, Rochester, N.Y.; $26 million in assets; 3.25 percent load; $2,000 minimum; up 27.26 percent.

* Pacific Horizon Capital Income Fund, New York; $45 million in assets; 4.5 percent load; $1,000 minimum; up 26.54 percent.

Rising interest rates can damage the value of existing bonds.

"Assuming economic activity continues at its current pace or modestly higher, there will be no more easing by the Federal Reserve," predicts Richard Davis, executive vice president with Duff & Phelps. "I prefer the intermediate bond maturity range of five to 10 years, since it doesn't make sense at this point to own long-term or very short-term debt."

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