A Mix of High Yields, Global Variety--and Risk
Wall Street’s pin-striped chefs seem to have hit upon a winning recipe. They’ve whipped up a new type of bond fund that combines two ingredients savored by investors: high yields and global diversification. They’ve mixed in hedging strategies to reduce risk to a palatable level.
This new creation is called the short-term global bond fund, and it’s selling like hot cakes. From one such fund with $329 million in assets at the start of 1990, the field has mushroomed to at least 10 portfolios with $8 billion under management.
Investors hope to earn a return that’s higher than money market yields while sidestepping the volatility of longer-term bond funds. The short-term global portfolios are really just a special type of international bond fund, where extra care is taken to reduce fluctuations in the share price.
Thomas Berger, a London-based portfolio manager of the Blanchard Short-Term Global Income Fund, which is based in New York, estimates that the price of his fund will rise or fall by only 3% or so in a year.
Looking at it another way, Bob Sinche, manager of the Alliance Short-Term Multi-Market Trust, figures that his fund has about as much volatility as an index of one- to three-year Treasury notes. Alliance’s product, the oldest and largest of the new global funds, posted a return of nearly 22% from its inception in May, 1989, through December, 1990. No other such funds have been around more than a year.
The Blanchard and Alliance products, along with the other short-term global funds, are designed to capture foreign bond yields that exceed those in the United States. It’s not uncommon to find short-term rates in the neighborhood of 12% to 14% in countries such as Spain, Britain, Sweden and Australia. “The level of interest rates is largely a function of where each country is in its economic cycle,” Berger explains.
With America in a recession and the Federal Reserve trying to stimulate growth, short-term yields in the United States have fallen to where they’re now among the lowest in the world. Berger describes a person who invests exclusively in the U.S. bond market as a “one-club golfer.”
Although the funds offer relatively high short-term yields, it’s important to realize that they’re not as stable as money market portfolios or guaranteed against loss--like bank certificates of deposit. “If money market funds are yielding 6% to 7% and this product pays 12%, you have to realize there’s some added risk,” says Kurt Brouwer, a San Francisco money manager and author of a book on mutual funds.
With the huge amount of cash rushing into short-term global bond funds, he worries that many investors don’t understand what they’re getting into and could wind up getting burned. “This is the fourth bond fund fad in recent years,” Brouwer says. In the three previous cases--involving Ginnie Mae funds, closed-end portfolios and junk bond funds--performance ranged from lackluster to poor.
To their credit, the short-term global products have made an attempt to cut risk across the board.
There’s little default danger because the funds typically stick with debt securities issued by foreign governments and top-tier corporations, as well as some foreign bank CDs.
The funds minimize both default and interest rate risk by maintaining a short-term focus. For example, the average maturity is 13.3 months for the Alliance fund and 14 months for Blanchard’s. By contrast, most longer-term international bond funds buy in the three- to 13-year range, sometimes further out.
Currency risk stands as the third and most critical type of danger assumed by the short-term funds. “It’s the primary risk and the one we hope to neutralize through hedging,” Sinche says. In general, international funds appreciate when the dollar falls because that boosts the relative value of foreign securities. By contrast, a strengthening greenback hurts these investments.
One way portfolio managers counter the currency risk is by keeping a portion of assets in U.S. bonds. Sinche, for example, must maintain at least a 25% domestic weighting, and he can go up to 100% should a rising dollar or higher domestic rates make the U.S. market more attractive. Also, the funds will typically hold some bonds denominated in foreign currencies--such as the Canadian dollar--that tend not to change much in relation to the greenback.
But hedging provides the main defense.
Many of the short-term global funds buy bonds in a high-yielding foreign market while selling short those in a lower-yielding country. This “cross-hedging” technique doesn’t work perfectly because there’s always a chance that the dollar could appreciate against the former currency while dropping against the latter. But it’s less expensive than a full hedge, Sinche says.
The costs associated with hedging for the Alliance fund reduce the net yield by about 80 or 90 basis points (0.8 or 0.9 of a percentage point) annually, he adds.
Critics don’t see the hedging costs as insignificant. They note that these outlays, when coupled with other mutual fund expenses such as management fees, can amount to nearly 2% a year--a big bite on an income portfolio.
“We’re concerned about the costs of running one of these funds,” says Brian Mattes, a vice president for the Vanguard Group, one of several fund companies that decided not to offer a short-term global product. “Besides, to the extent you hedge, you remove one of the potential advantages of these funds.”
Fee-conscious investors will also be discouraged that hardly any no-load companies have entered the field. Nearly all the existing short-term global bond funds come with a sales charge of one type or another. Some carry a modest upfront fee of 3% or so, while others impose a back-end levy ranging from 3% down to nothing, depending on when the investor sells his or her shares.
Blanchard (800-922-7771) claims to have the only no-load fund in the bunch, although it charges a $37.50 account-opening fee ($75 after May 31).
The largest short-term global funds include those from Alliance (800-227-4618), Merrill Lynch (800-637-3863) and Prudential-Bache (800-225-1852).
Of these, only the Alliance portfolio has been around more than one year. Without a lengthier track record to examine, investors can only hope that the funds are able to match Alliance’s early success. Critics such as Mattes believe that the dollar is due for a prolonged rally, which could drag down performance. Proponents counter that the funds would still be able to beat money market rates, thanks to the defensive strategies.
Only time will tell.
HIGHER YIELDS IN OTHER MARKETS
Short-term global bond funds try to take advantage of higher yields available elsewhere in the world. Interest rates vary from country to country and change over time. But at the moment, the funds have a strong selling point because U.S. short-term yields are among the lowest in the world, as indicated by this sample of three-month deposit rates in selected markets as of Jan. 31, 1991.
Spain: 14% Britain: 13.81% Sweden: 13.81% Australia: 11.86% New Zealand: 11.5% Canada: 10.37% Germany: 9.18% Japan: 8.12% United States: 6.93%
