Fed cuts have helped bond investors

But short-term government funds may have had run

September 02, 2001|By Scott Berry | Scott Berry,MORNINGSTAR.COM

Short-term government bond funds have carried their momentum well into 2001, but the party could be nearing an end.

Weak economic numbers and corporate earnings warnings may be bad news for stock funds, but they've helped short-term government-bond funds gain an average of 5.2 percent for the year to date through Aug. 17. While most of the Federal Reserve's early-year rate cuts were priced into the market in 2000, the Fed has had to cut deeper than most bond market participants had originally forecast and bond investors have been the beneficiaries.

The biggest winners in the short-term government category in 2001 have been those funds that invest in Treasury Inflation-Indexed Securities (TIPS). Increased investor acceptance of TIPS, periodic inflation concerns and a fear that the Treasury may slow or stop their issuance have given these nontraditional Treasury bonds a big lift.

While this category's Analyst Picks haven't kept pace with the category-leading TIPS offerings, they have continued to outpace their average short-term government peer. Vanguard Short-Term Federal has used its hoard of agency bonds and its ultralow expense ratio to outpace its average peer by more than 1 percentage point, while Sit U.S. Government Securities and Montgomery Short Duration Government Bond have posted their typical solid gains.

However, with short-term Treasury yields at their lowest points since 1972, the rally may be nearing an end. Indeed, with the bond market pricing in one or two additional rate cuts, short-term government bonds will be hard-pressed to match their recent gains unless the economy continues to slow.

Vanguard Short-Term Federal: In a category where the winners and losers are often separated by less than 1 percentage point, expenses play a huge role. And like all Vanguard funds, this one is hard to beat on that front. Indeed, its expenses are so low that its run-of-the-mill strategy has produced topnotch long-term returns. Over the past few years, the fund has focused on agency bonds, which tend to yield a bit more than Treasuries.

Montgomery Short Duration Government Bond: This fund uses all the clubs in its bag to stay ahead of its rivals. Its mix of Treasuries, agencies, mortgages, asset-backs and even corporate bonds has helped it perform well in a wide variety of markets and has helped limit its volatility. While the fund is not as cheap as Vanguard's offering, it is substantially cheaper than its average short-term government peer.

Sit U.S. Government Securities: This fund rarely disappoints. The added yield provided by its large mortgage stake has helped limit its volatility while helping it deliver impressive long-term returns. Like the Montgomery offering, this fund delves into all areas of the government-bond market including GNMA mobile-home mortgages, which have given the fund a lift in years past.

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