How and when to find the right U.S. bond fund



Are you looking for a top-quality bond fund? You are not alone. Funds that own only U.S. government securities have outsold all other bond funds, although long-term municipal bond funds have nearly caught up with them.

But are government bond funds right for you? Is this a good time to begin investing? And how should you choose a fund?

First, consider whether you can accept the risk that the price of fund shares is likely to fall as interest rates rise. That risk tends to increase with the length of maturities of a portfolio's bonds.

The fact that the Treasury may stand behind some or all of its bonds won't keep the share price from falling as interest rates rise. It means only that the Treasury guarantees to pay interest and repay principal on time -- even if it must borrow to do so.

But all government bond funds aren't concentrated in Treasury notes and bonds. And they involve other risks.

The best time to buy a bond fund's shares is when interest rates are likely to fall, causing bond prices to rise. With interest rates lower than in years, rates may be unlikely to fall. They certainly have less room to fall. Still, nobody knows whether rates will slip, rise or remain stable.

Testifying recently before Congress, Alan Greenspan, chairman of the Federal Reserve Board, said the Fed was prepared to tighten when it perceives inflationary pressures, but he did not predict the direction of long-term rates.

Others have forecast all over the lot. Economists, surveyed semiannually by the Wall Street Journal, predicted a year ago that rates for 30-year Treasury bonds would be anywhere from 5.5 percent to 8.5 percent on June 30. The actual rate: 6.68 percent.

In the most recent survey last month, their forecasts for rates next June 30 ranged nearly as widely: 5.5 percent to 8 percent.

So, what do you do? Consider how long you plan to be invested and decide what maturity range would be compatible with your goal and risk tolerance.

In choosing a government bond fund, remember there are several categories. Lipper Analytical Services uses six: short-term, intermediate-term, general U.S. Treasury, U.S. government funds, GNMA and U.S. mortgage funds.

General U.S. government funds is by far the largest category, with more than 130 funds.

Unlike Treasury funds, which invest primarily in Treasury issues, government funds invest also in issues of federal agencies. The issues may -- or may not -- have the full faith and credit of the Treasury behind them. Average maturities may exceed 10 years.

Understand the investment policies of the fund you are considering. Some give the portfolio manager flexibility to invest in a range of sectors and maturities. Examples:

* Some maximize income, possibly giving up opportunities for appreciation. Others try to maximize total return, possibly sacrificing opportunities for income.

* Some, like Fidelity Government Securities, invest in issues that generate dividends exempt from state and local income taxes.

* To minimize risk, some, like Voyageur U.S. Government Securities, may own only securities backed by the Treasury. This enables them to buy mortgage-backed securities guaranteed by the Government National Mortgage Association -- but exposes them to prepayment risk.

* Others may own mortgage-backed securities of the stockholder-owned Federal Home Loan Mortgage Corporation and Federal National Mortgage Association.

* A few, like Heartland U.S. Government and Strong Government Securities, buy corporate securities.

Co-manager Patrick J. Retzer says his Heartland Fund achieved its pace-setting annual average of 12.6 percent over the last five years by varying maturities and rotating among Treasuries, federal agencies, mortgage-backed securities and Treasury zero-coupon securities.

Voyageur's Jane Wyatt is confident that long rates will remain stable but is cautious, staying with intermediate maturities. As falling interest rates raised prepayment risk, she cut her GNMAs from 90 percent a few years ago to 10 percent. The current holding: 30 percent.

Margaret Patel, whose Advantage Government Securities had been only in GNMAs until early 1992, slashed them to 9 percent and built up Treasury positions. "Long rates are still a buy," she says.

For a portion of Strong's portfolio, Bradley Tank buys high-coupon mortgage-backed securities that remain outstanding because homeowners haven't refinanced the underlying mortgages.

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