Investors get rude awakening on bond funds

April 27, 1994|By Andrew Leckey

A bond fund is not the same as a money market fund or a certificate of deposit.

That's been said before, but it unfortunately required a sledgehammer event to drive it home to a large number of investors this year. Too many had begun using bond funds as vehicles for everyday savings and checking, rather than strictly for long-term investment.

The painful correction in the bond market points out that fixed-rate investments face not only credit risk, but interest-rate risk as well. Rising rates, a phenomenon not seen in a while, quickly diminished the value of existing bonds.

Recent quarterly statements sent out to bond investors by investment houses bear the sad numbers. Millions of dollars were erased in investor accounts during the debacle.

Municipal bond funds plummeted an average of 5.24 percent in value; international bond funds tumbled 4.51 percent; Treasury bond funds fell 3.68 percent; high-quality corporate bonds funds were down 1.91 percent; and high-yield "junk" bond funds slipped 1.14 percent.

"Inflation won't come back and we won't see the large losses of the first quarter continue throughout the year, so longer-term investors have no cause for panic," observed Don Phillips, publisher of the Morningstar Mutual Funds advisory service. "However, people who wandered into these bond funds seeking higher yields but who really have a saver's mentality, might consider getting back into money markets again."

Higher bond yields are compensation for assuming higher risk. An investor must choose among the risks of interest rates, credit quality, length of maturity and foreign currency, which exist to varying degrees in different types of bond funds.

Short-term bond funds attempt to provide higher income than money market funds while keeping volatility relatively low.

"We were able to come up with a 0.72 percent positive total return in the worst quarter for short-term bonds in 10 years, using a 90-day portfolio of 65 percent corporate bonds and 45 percent mortgage securities," explained Jeffrey Koch, portfolio manager for Strong Advantage Fund, who believes annualized inflation at the very worst will rise only one-half to 1 percent.

A year from now, he expects long-term bond yields to be about where they are now, while short-term rates will be about one-half percentage point higher.

Top-performing short-term taxable bond funds in total return (yield plus price appreciation of underlying bonds) over the past 12 months, according to Morningstar, were:

* Strong Advantage, Menomonee Falls, Wis.; $575 million in assets; "no load" (no initial sales charge); $1,000 minimum; up 6.23 percent.

* Alliance World Income Trust, New York; $113 million in assets; no load; $10,000 minimum; up 4.92 percent.

"A lot of investors who moved out of cash into bond funds for higher yields are losing now, but hopefully they won't be the first to jump out while the market's at the bottom," said Bruce Monrad, portfolio manager of high-yield fund Northeast Investors Trust.

"We never used to think there was any interest rate risk in junk bonds, but we've now learned there is, so we're watching daily how Treasuries are performing."

Noted for their credit risk, junk bonds proved susceptible to rate risk as well when the spread between their yields and those of Treasuries grew narrower earlier this year.

Best-performing high-yield bond funds over the past 12 months were:

* Dean Witter High Yield Securities, New York; $555 million in assets; 5.5 percent load; $1,000 minimum; up 20.73 percent.

* Northeast Investors Trust, Boston; $514 million in assets; no load; $1,000 minimum; up 17.32 percent.

Strategy makes a difference. A number of international bond funds that performed best didn't do so because of bond holdings. Instead, they excelled by scaling back bonds in their portfolios and playing up currencies and stocks.

The most successful international bond funds were:

* FT International Income "A," Pittsburgh; $246 million in assets; 4.5 percent load; $500 minimum; up 19.97 percent.

* Fontaine Global Income Fund, Towson, Md.; $800,000 iassets; no load; $1,000 minimum; up 12.37 percent.

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