As bond prices steady, yields a factor to watch

July 17, 1995|By Bloomberg Business News

NEW YORK -- When bonds stop rallying, bond yields matter more.

Investors say those bonds that pay the most will do best in the second half of 1995, after a first-half surge in bond prices.

The rally can't keep going at the pace of the first six months, they say, so it's time to look for securities that provide a bit more yield than U.S. Treasuries. The potential winners are corporate, municipal and mortgage-backed bonds.

"We've structured [our funds] with the idea that what will be important will be coupon income rather than price appreciation," said Denis Jamison, who oversees more than $550 million at Lexington Management in Saddle Brook, N.J.

"We don't think there's much more to the rally."

He is counting on low interest rates to resuscitate the economy, especially the housing market, where sales are rising and lenders taking in more mortgage applications.

"We think the money is going to be made in coupon income," he said.

"Yields have dropped from 8 percent to about 6.6 percent. They could go to 6.5 percent, or even 6.25 percent, but most of the big money has already been made."

Corporates could spend the year in the top spot if investors are right. Corporates have earned more money as a group than any other U.S. bond market so far, according to figures from Lehman Brothers.

The bonds returned 13.8 percent through June, two points more than Treasuries. Mortgage-backed securities returned 10.73 percent.

Total return is the interest in come on a bond, plus reinvested interest and principal, and any change in the bond's price. Sometimes, as in the first half of this year, a bond's price contributes more to its return than interest income.

The price of the Treasury's 30-year bond, for example, rose 16 percent this year, accounting for almost all of the 19.7 percent return.

The yield on the 30-year bond fell 126 basis points in the first six months of the year, to 6.62 percent.

The record low yield since the Treasury began selling bonds regularly in 1977 is 5.79 percent, set in October 1993. If it holds, it will be the biggest one-year plunge in yield since 1986, when the bond fell 217 basis points to 7.27 percent.

As much as yields fell this year, they can't possibly fall a similar amount in the next six months. Investors say they recognize that price appreciation won't be as big a component of their return as it was in the first half, and that absolute yield is the best way to play the game.

Robert Schumacher, chief bond strategist for Kemper Mutual Funds in Chicago, said much of the firm's $25 billion of debt securities is invested in noncallable corporate bonds because they yield more than benchmark Treasuries.

An "A"-rated industrial company bond that matures in 10 years yields 6.88 percent, or 70 basis points more than a 10-year Treasury note.

These bonds "are going to have something that all investors want: coupon income," Mr. Schumacher said. "It makes sense to own noncallable, income-producing assets in the environment we see for the next six months. So we like corporate bonds, and we like them a lot."

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