Fidelity Seeks to Put the Boring Back in Bonds
Industry leader Fidelity Investments of Boston is the latest firm to take a crack at an old and still unpopular idea: bond mutual funds that truly behave like bonds.
Most bond funds don’t act like the securities in which they invest. They don’t pay a fixed yield. They don’t mature on a specific date. And they don’t promise to repay an investor’s original principal.
Instead, most funds have indefinite lives. As existing bonds mature or are sold off, the funds purchase new holdings. As new bonds enter a portfolio, its overall yield changes.
In years past, when prices for both bonds and bond funds seemed immune to sharp declines, investors didn’t seem to mind that the funds were less predictable than the underlying investments. But that mind-set was shaken in 1994, one of the roughest years for bonds and bond funds ever.
Even though the bond market in 1995 regained all of the ground it lost the prior year and then some, many investors have stayed away. At Fidelity, stock funds last year outsold bond portfolios by a 28-1 margin.
“We didn’t see investors coming back to bond funds all that aggressively,” says Robyn Tice, a Fidelity spokeswoman in Boston. “Our research shows that investors now are looking for a greater degree of predictability.”
So to complement its existing stable of 65 conventional bond portfolios, Fidelity in mid-February introduced three Target Timeline funds, each maturing on a specific date and paying a fairly predictable return. Portfolio manager Christine Thompson, who oversees two other Fidelity bond funds, intends to achieve these goals by holding a mix of government and corporate bonds with maturities matched to each fund.
Of the three funds, the Target Timeline portfolio that liquidates on Sept. 30, 1999, will probably deliver the lowest performance. It is designed to pay present investors somewhere between 4.47% and 5.77% each year over that span.
A second fund, maturing on Sept. 30, 2001, will offer returns between 4.81% and 6.11% annually, and the 2003 portfolio between 5.17% and 6.47%. Investors must hang on to their shares until the liquidation date to earn the expected return. Anyone buying shares later can expect different performance ranges.
Fidelity’s decision to unveil these funds now reflects lackluster demand for bond funds, Tice adds, rather than a forecast of declining bond prices.
One problem with target-maturity funds involves cost. All mutual funds charge ongoing operating expenses to pay for the portfolio manager, shareholder services, marketing and more. With individual bonds, investors can avoid these charges.
Fidelity intends to minimize this problem by keeping costs low. There are no sales charges to purchase the Target Timeline funds, and annualized expenses are currently limited to a quite reasonable 0.35%, or $3.50 for each $1,000 investment. In exchange, investors receive diversification, professional management and other benefits. Plus, mutual funds can trade bonds for much lower commissions than individuals can.
Fidelity ([800] 544-8888) requires a minimum purchase of $2,500 for the Target Timeline Funds, except for retirement accounts, for which the threshold is $500.
Although the Target Timeline portfolios are Fidelity’s first attempt at offering mutual funds that behave like bonds, others firms have pursued this angle in varying ways.
For example, the Benham Group of Mountain View, Calif., offers a series of five Target Maturities portfolios coming due every five years from 2000 to 2020. The funds ([800] 331-8331) count a combined $1.5 billion in assets. They invest in zero-coupon Treasury bonds maturing in the appropriate year. Owing to the volatile nature of zeros, these funds bounce around more in price than the Fidelity portfolios are likely to.
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Another approach is to package stocks and zero-coupon bonds in the same portfolio--a mix that ensures shareholders will at least recoup their original investment if they hang on until the maturity date. For example, American International Group of New York recently introduced its AIG Children’s World Fund-2005 ([800] 862-3984), designed to help finance a youngster’s college education by guaranteeing a return of the original amount for investors who sit tight the full nine years.
Funds that target a minimum return on a future date are most appropriate for people who know they will need to spend the cash then--for college, retirement or whatever.
“Matching assets to a target maturity does make sense,” says John Isaacson, chief investment officer at Payden & Rygel Investment Group, a Los Angeles firm that manages 10 conventional bond funds.
The concept appeals to people willing to forsake some upside potential for the assurance that they won’t get mauled on the downside.
“If you’re comfortable with, say, a 6% return, don’t care so much about making more but would be upset if you earned less, a target fund can be suitable,” he says.
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James Gipson, manager of the Beverly Hills-based Clipper Fund, sees the current tug-of-war on Wall Street as pitting Young Lions against Old Codgers. “Young Lions, who now comprise the majority of investment professionals, have no personal experience with an extended bear market,” writes Gipson in the fund’s recently released annual report. They believe in a new era of peace, productivity and profit, and they rank a bear market as a distant possibility.
Old codgers, by contrast, can’t understand why a bear market has not happened already, as valuations seem extended. “Their view has a moral quality to it: Too much money has been made too fast by too many undeserving people,” Gipson writes.
While the Young Lions are right about corporate America’s profitability, the Old codgers might be right about the market’s direction. “Most companies probably will find it difficult merely to maintain today’s extraordinary profits, so growth from the current peak is likely to be the exception rather than the rule,” according to Gipson.
