Bond information can help mutual fund investors assess impact of rise in yields

MUTUAL FUNDS

April 17, 1994|By WERNER RENBERG | WERNER RENBERG,1994, Werner Renberg

Now that first-quarter performance data for bonds and bond funds are available, you can assess the impact of the increase in yields that has occurred since the Feb. 4 decision of the Federal Reserve's Federal Open Market Committee to raise short-term interest rates.

As you study data for funds that you own or wish to invest in, you can compare them with their peers and with appropriate benchmarks to judge anew whether the funds are -- or would be -- suitable for you now, given your investment objectives, risk tolerance and investment horizon.

Before making any buy or sell decisions, though, you may want to wait until you get the funds' reports to shareholders for the period ended March 31, which should be ready in a few weeks, so that you can read the managements' discussions of performance and strategies.

The FOMC acted, as you recall, because it sensed the possible emergence of inflationary pressures in some sectors of the economy andwished to nip them in the bud -- not because the nation had already begun to experience an alarming increase in the consumer price index.

Whether its February action, followed by similar move on March 22, will have the desired effect, the March CPI report confirmed that the inflation rate has not yet accelerated significantly.

While you might indeed support the Fed's strike against possible future inflation -- some observers would have preferred it if the FOMC had acted sooner, more boldly, or both -- there is no doubt that it has had an impact on you if you own bond funds (or other securities).

To size up the bond market's recent drop, look at Salomon Brothers' Broad Investment-Grade Bond Index, which tracks the entire $4.2 trillion market of taxable investment grade securities (of which Treasury issues make up 46.1 percent; mortgages, 29.5; corporates, 18.9, and government-sponsored agencies' debt, 5.51.)

After the index's negative total return of 1.66 percent in February, March brought a negative 2.48 percent -- its worst monthly return since May 1984 -- that resulted in a negative 2.81 percent for the first quarter and a positive 2.56 percent for the last 12 months.

The impact on you may have been most severe if you had redeemed shares, thereby not only realizing losses but perhaps also depriving yourself of the chance to recover if and when interest rates decline.

Presumably, you're still holding. How you've fared has depended not only on the types of funds in which you're invested but also on whether you've taken dividends in cash or reinvested them, thus compounding income and buying more shares when prices are lower.

You see the difference when you compare total returns, which reflect reinvestment of income and capital gains distributions, with principal-only data, which reflect reinvestment only of the latter.

The drops in the principal values of bond fund groups, on the average, were too large to be offset by only three months of income dividends, according to Lipper Analytical Services.

But it was a different story for the twelve months ended March 31.

All groups posted positive total returns, even if several did lag or barely match the 2.6 percent average return for money-market funds.

Virtually all, with exceptions such as convertible securities and high yield funds, suffered losses in principal, however.

Thanks to the fall in interest rates over the last five years, even principal-only results were positive -- generally averaging around to 2 percent annually -- despite the first quarter's showing. High yield funds were an exception, off an average of 1.5 percent yearly because the period still reflects their poor performance in 1989-'90.

Total returns generally averaged 8 to 9.5 percent annually, down from 8.5 to 11 for the five years ended last Dec. 31.

Looking at the first quarter's total returns for the various categories, at least one thing stands out: duration, a measure of a bond's sensitivity to interest rate changes, mattered a lot. (Duration reflects both a bond's coupon and its maturity.)

Bond funds with short durations, which fall less when interest rates rise, suffered small declines. Bond funds with long durations, which had been appreciating more until October -- and which pay fatter dividends -- fell more, just as predictably.

What should be your strategy now? Consider whether the funds you're in are suitable for you and whether they have been performing as well as you could expect.

For risk-averse investors, Ian A. MacKinnon, Vanguard senior vice president in charge of its fixed income group, suggests a "barbell" approach -- a blend of short- and long- term funds in proportions compatible with their risk tolerance -- may be appropriate now.

"Most of the damage to long-term rates has been done, but there's still room for short-term rates to go higher," says MacKinnon, who most recently shortened his funds' durations just before the Fed tightened and who lengthened them again -- slightly -- a few days ago.

One group of funds for which durations could not be adjusted as easily: funds owning GNMA securities.

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