Patience Remains a Virtue for Bond Fund Investors
Bond mutual funds last year turned in their best performance since 1991, more than making up for their painful losses in 1994--and rewarding investors who’ve had the patience to just sit tight.
But that patience may be tested again this year, many analysts warn, if unexpected strength in the economy or unexpected stupidity in Washington throw the now-ebullient bond market for a loop.
The average taxable bond fund gained 15.2% in 1995, with more than half of that return coming from price appreciation as market interest rates tumbled and older bonds jumped in value, according to figures released Thursday by fund-tracker Lipper Analytical Services.
In contrast, the average taxable fund had a negative return of 3.3% in ’94 as the devaluation of older bonds (caused by soaring interest rates) more than offset the yields they earned.
Despite interest rates’ gyrations over the past five years the overall trend in yields has been down, and that has rewarded buy-and-hold bond investors. Combining interest earnings and price appreciation, the average long-term government bond fund has earned 49.5% over five years.
That is less than half what the average stock fund investor earned in the same period. But if bond fund owners were seeking income, they probably wouldn’t have considered stock funds anyway. Bond funds’ natural competitors are money market funds--and they have been poor competition since 1990: Money funds’ average return over five years has been a mere 22.3%.
Yet many income-oriented mutual fund investors still keep huge sums in money market funds. Total assets of noninstitutional money market funds (taxable and tax-free municipal) total about $510 billion. By comparison, there is just $73.5 billion in U.S. government bond funds.
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Whether many of those money-market fund investors will consider switching to longer-term funds is a key question for the bond market in 1996. With the Federal Reserve Board poised to further reduce short-term interest rates, the average money fund yield--now 5.1%--is likely to fall under 5% early this year.
Current yields on longer-term bond funds, in contrast, are generally above 5.5% and can easily top 7%, depending on the type of fund.
But some bond pros say those yields simply aren’t high enough to attract long-term investors, many of whom are too afraid of another whipsaw in rates if inflation were to revive or if Congress and President Clinton fail to strike a budget accord.
James Bianco, bond expert at Arbor Trading Group in Barrington, Ill., argues that the unwillingness of true investors to buy bonds at these yields leaves the market increasingly in the hands of short-term speculators. For now, those speculators are pushing yields lower. But they could just as easily turn and sell, fueling the whipsaw that investors fear, Bianco says.
Still, bond market proponents say the lesson of the last two years is that interest rates remain in a secular downtrend, driven by low inflation, an aging population and the pressure on governments worldwide to cut expenditures and borrowing.
What’s more, some argue that bonds now are a less-risky investment than stocks, especially if the economy continues to slow. “Relative to stocks we think bonds are more attractive,” says Cathy Jameson, fixed-income director at Wood, Struthers & Winthrop in New York. In the fourth quarter, in fact, bond funds generally outperformed the 3.06% gain of the average stock mutual fund.
For investors who want to make a bond bet now, many experts favor three categories:
* Municipal funds. Despite Republican proposals to eventually eliminate muni bonds’ tax-advantaged status, the average general muni fund gained 16.8% in 1995. That was a better return than the 17.4% average gain of long-term U.S. government funds, when you factor in munis’ tax-free interest.
And California muni funds had a particularly good year, up 18.3% on average as California bonds rebounded from the Orange County debacle.
With muni yields still historically high relative to yields on taxable government or corporate bonds, “If you’re going to invest in fixed-income markets in 1996, invest in munis,” argues Richard Ciccarone, muni research chief at Everen Securities in Chicago.
* High-yield “junk” corporate funds. If it’s high income you’re after, junk funds are still the place to be. The average fund yields 9.4%, according to Lipper. The average total return in 1995: 16.4%.
The full-year return was below expectations because the junk market has been anticipating a rising number of defaults in 1996, says Kingman Penniman, high-yield analyst at Duff & Phelps Inc. Yet the junk market’s history shows that, over time, the high yields earned more than compensate for the defaults that occur, he notes.
* Global bond funds. Foreign bond markets had a good run in 1995, but with interest rates expected to decline further overseas these high-risk funds could shine again. Many pros, however, recommend them for short-term speculators only.
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How Bond Funds Fared Here are average total returns for key categories of bond mutual funds for three periods ended Dec. 29. Total return includes interest earnings plus or minus any change in the bonds’ principal value. *--*
Average total return Fund category 4th Qtr. 1995 5 yrs. Calif. muni bonds, long-term +5.20% +18.3% +49.1% Lower-quality corporate bonds, long-term +4.73 +20.1 +69.1 General muni bonds, long-term +4.66 +16.8 +50.3 Global bonds, long-term +4.59 +18.0 +47.9 High-quality corporate bonds, long-term +4.53 +18.5 +58.9 U.S. govt. bonds, long-term +4.41 +17.4 +49.5 Mixed bonds +4.12 +18.0 +75.4 High-quality corporate bonds, 5- to 10-year +3.99 +16.6 +53.0 U.S. govt. bonds 5- to 10-year +3.76 +15.8 +47.6 GNMA bonds +3.44 +16.3 +47.8 Junk corporate bonds +2.94 +16.4 +118.4 U.S. govt. bonds, 1- to 5-year +2.73 +11.3 +37.9 High-quality corporate bonds, 1- to 5-year +2.51 +10.8 +41.3 Global money market +2.39 +7.8 +21.2 Money market +1.25 +5.3 +22.3 Adjustable rate mortgage bonds +0.59 +4.9 +27.1
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Source: Lipper Analytical Services Inc.
