With rates stabilizing, reconsider bond funds

October 19, 1994|By Andrew Leckey | Andrew Leckey,Tribune Media Services Inc.

Gotta run.

That's been the attitude of many harried investors in bond funds this year as they flee the effects of rising interest rates and continuing scares over misuse of derivative securities by some portfolio managers.

Since the value of high-yield "junk" bonds is based in large part on credit quality and not merely yield, these funds have been hurt the least. As a result, outflows from junk bond funds this year have totaled only $2 billion.

Tax-exempt municipal bond funds, buoyed by the laws of supply and demand, have seen about $11 billion go out the door.

However, the value of investment-grade taxable bond funds, which live or die by interest rates, was hammered the hardest. Nervous investors viewing the dismal results took a whopping $39 billion out of these funds. Bank accounts and money-market funds were likely beneficiaries of those fleeing dollars.

With the possibility of a more stable interest rate environment ahead, it's now time to stop and think rather than just run and hide. Unless you can really find a better place to put your money or you're a short-term investor, you shouldn't be so quick to bolt from your bond fund.

"It's true that if people think interest rates are going to rise dramatically, they shouldn't be thinking about bond funds, at least for the short term," counseled Jeff Kelley, associate editor of the Morningstar Mutual Funds investment advisory, which tracks the nation's funds.

But, if they're already in bond funds and have a five- to 10-year time horizon, he added, they should stay the course and realize rate movement is simply an inherent part of the bond market.

Investors should also keep in mind that longer-term bond funds carry greater risk from rate gyrations than those holding bonds of shorter duration, which is why the most successful funds the past 12 months kept maturities short.

"We stayed relatively short with a bond maturity of seven years, we avoided foreign or gambling casino bonds, and we emphasized bonds of cyclical industries such as chemical and paper companies," said Ernest Monrad, co-manager of Northeast Investors Trust, top-performing junk fund with a solid 10.96 percent total return over 12 months.

Best junk bond funds to be in over the past 12 months, according to Morningstar, were:

* Northeast Investors Trust, Boston; $582 million in assets; no load (no initial sales charge); $1,000 minimum; total return of 10.96 percent.

* Mainstay High Yield Corporate Bond, Parsippany, N.J.; $1.1 billion; 5 percent back-end load; $500 minimum; total return of 7.96 percent.

* MetLife-State Street High Income, "A" Shares, Boston; $728 million; 4.5 percent load; $500 minimum; total return of 6.65 percent.

Concern over taxes means tax-exempt municipal bonds offer built-in resilience, though even they can be tested during difficult periods.

"The supply of municipal bonds has been lower this year than it was last, yet the demand has been lukewarm because of the rise in interest rates," noted Reno Martini, portfolio manager of Calvert Tax Free Reserve Limited Term Portfolio "A" shares, up 2.84 percent in total return.

He outperformed by keeping holdings "very, very short," currently at a nine-month average maturity.

Top results for national tax-exempt municipal bond funds over the 12-month period were:

* Twentieth Century Tax Exempt Short-Term, Kansas City, Mo.; $58 million in assets; no load; $10,000 minimum; total return of 2.93 percent.

* Calvert Tax Free Reserve Limited Term, "A" Shares, Bethesda, Md.; $263 million; 2 percent load; $2,000 minimum; total return of 2.84 percent.

* Venture Muni Plus, Santa Fe, N.M.; $188 million; 4 percent back-end load; $1,000 minimum; total return of 2.8 percent.

While defensive funds do best in times of rate rises, they won't offer the same upside potential if rates are in steady decline.

"Our fund is designed to be defensive, with short average maturity (currently about a year and a half) and little interest rate risk," said Tad Rivelle, co-manager of the Hotchkis and Wiley Low Duration Fund, up 5.38 percent. "We also rotate our portfolio between Treasuries, corporate bonds and mortgage-backed securities . . . ."

Best returns in investment-grade taxable bond funds over 12 months were:

* Hotchkis and Wiley Short Term Investment, Los Angeles; $12 million; no load; $5,000 minimum; total return of 5.80 percent.

* Hotchkis and Wiley Low Duration Fund, Los Angeles; $60 million; no load; $5,000 minimum; total return of 5.38 percent.

* Strong Advantage Fund, Menomonee Falls, Wis.; $784 million; no load; $1,000 minimum; total return of 4.74 percent.

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