Rush to Bond Funds May Speed Up
Investors who poured billions of dollars into bond mutual funds last year were rewarded for their faith: Most bond fund categories produced handsome double-digit returns of 12% to 17% in 1991, fund tracker Lipper Analytical Services reported Tuesday.
The big laggards, meanwhile, were money market funds--which many Americans came to view in the 1980s as the crucial “third leg” of their investment tripod of stocks, bonds and short-term investments.
The average money fund’s return last year was a mere 5.7%, as short-term interest rates plunged to 27-year lows with the weak economy, Lipper said.
With interest rates still declining, many experts say older investors who have long depended on money market funds for income will have little choice but to switch to bonds or other higher-paying--and inherently riskier--investments.
That switch accelerated throughout 1991, of course, but it now may reach tidal-wave proportions, some analysts fear.
“A lot of people just can’t live on 4.5% interest,” says Glen King Parker, publisher of the Mutual Fund Forecaster newsletter in Ft. Lauderdale, Fla. “This is the new impoverished class of people in this country.”
Indeed, in the last week of December, assets of money market funds plummeted $21 billion to $458 billion as an untold number of investors shifted their dollars to bonds and stocks.
Despite the flood of money into bond funds, fund assets total just $460 billion--almost exactly the amount still in money market funds. There is even less in stock mutual funds: About $350 billion. So Wall Street believes that there still is massive potential for cash to flow from money funds into bonds and stocks.
The irony of the new rush to bonds is that it’s probably late in the game to try to lock in higher interest rates, some analysts caution.
Parker, in fact, is advising clients still in money market funds to stay there and wait for interest rates to turn up later this year, which he assumes will happen with a strengthening economy.
But many professional money managers say investors would be wise to put some of their money in bonds, on the bet that a slow-growth economy will mean generally low interest rates for much of the early 1990s.
“Our view on short-term rates in particular is that we’re in for an extended period of low yields,” said Jeffrey Koch, portfolio manager at Strong Mutual Funds in Milwaukee.
Confused about how best to invest in bond mutual funds--and the risks involved? Before you take the plunge, consider these points:
* Don’t count on 1991 returns. The double-digit bond fund returns of last year are unlikely to be repeated this year, because market interest rates are unlikely to drop as dramatically in 1992 as they did in 1991.
Say you owned the average fund that invests in high-quality, long-term corporate bonds. Your total return last year was 16.4%, according to Lipper. But the interest yield on the fund was just 7.5% for the year. The rest of your return--8.9 percentage points--came from the bonds’ price appreciation. The drop in market interest rates made older, higher-yielding bonds more valuable.
Many experts believe that rates will stabilize in the next few months, meaning that bond owners probably won’t get much of a “kicker” return this year from price appreciation. That means that the interest yield on a fund may be all you earn this year--somewhere between 6% and 8%, generally, depending on the type of fund. You have to decide if that’s enough of a return to leave the safety of money funds.
* Shorter-term bonds still make sense. The big risk in buying bonds is the possibility that market interest rates will soar this year. That would depress the value of older bonds, potentially leaving you with a paper loss on your investment--even though you would still be collecting your interest yield.
If you stick with bond funds that own relatively short-term securities, however, the risk from rising interest rates will be much lower than with longer-term bonds. You will sacrifice some return, of course, because longer-term bonds pay more than shorter-term bonds. But the difference in returns can be very small.
Last year, for example, the average bond fund that owns five-year to 10-year high-quality corporate bonds earned 15.2%, slightly less than the 16.4% earned by funds buying the same type of bond, only of much longer maturities (10 years or more).
A. C. Moore, investment strategist at Argus Investment Management in Santa Barbara, notes that seven-year Treasury notes yield 6.4% now, while 30-year Treasury bonds pay only one percentage point more, at 7.4%. “To us, the optimal part of the yield curve still is six to seven years,” he says.
* Go with a mixed-bond fund. Having trouble picking a bond fund category--corporate, U.S. government, mortgage-securities, etc.? Go with a fund whose managers always own a mix of bonds.
Mixed funds are proliferating because even professionals realize that “it has been very perilous to pick the right bond category” in most years, says Don Phillips, editor of the Mutual Fund Values newsletter in Chicago. For example, depending on the economy and other factors, short-term corporate bonds might be rising in value while long-term Treasury bonds are declining.
Strong Mutual Funds’ Government Securities Fund has increasingly mixed its portfolio, Koch says, and now is split among corporate bonds, seven-year Treasury notes, 30-year Treasury bonds and mortgage-backed securities.
Other fund families offer similar mixed bond funds.
How Bond Funds Fared
Here are total returns--interest earned plus price appreciation--for key categories of money market and bond mutual funds for 1991 and for the last five years. The final number shows the average 12-month yield for each category.
Total return: 12-mo. Fund category 1991 5 years yield Junk corporate bonds +36.4% +36.5% 11.8% Mixed bonds +18.7% +51.1% 8.2% Lower-quality corporate bonds, long-term +16.9% +55.2% 7.6% High-quality corporate bonds (long-term) +16.4% +52.9% 7.5% High-quality corporate bonds (5- to 10-year) +15.2% +51.7% 7.1% GNMA securities +14.6% +57.0% 8.0% U.S. govt. securities (5- to 10-year) +14.5% +47.9% 7.1% U.S. govt. securities (long term) +14.5% +49.0% 7.4% World bonds +14.1% +73.0% 8.1% High-quality corporate bonds (1- to 5-year) +11.9% +47.8% 7.1% General municipal bonds, long term +11.9% +44.1% 6.2% U.S. govt. securities (1- to 5-year) +11.6% +46.4% 7.0% Adjustable-rate mortgage +8.1% NA 8.4% Money market +5.7% +40.9% 5.5% NA--not available (funds are too new)
Source: Lipper Analytical Services Inc.
