After 1st Period, Bond Funds Are Trailing Stocks

With three quarters to go in the 1996 investment derby, the score is stock funds 5.7%, bond funds less than zero.

The average bond mutual fund posted a negative total return of 0.9% in the first quarter, as rising market interest rates depressed older bonds’ prices and more than offset their interest earnings, fund-tracker Lipper Analytical Services reported Wednesday.

In contrast, the stock market powered ahead despite higher interest rates, with the average general U.S. stock fund rising 5.7% in the quarter.

For bond fund owners, the first quarter was an unpleasant reminder of the market’s turmoil in 1994, when the Federal Reserve Board began tightening credit, sparking a surge in interest rates that caused bond fund values to plunge.

In fact, bond funds that own longer-term securities suffered first-quarter losses that were close to their declines in the first quarter of 1994, when the Fed began to turn the screws.

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The difference this time was that market interest rates jumped with no Fed prompting. Wall Street drove longer-term yields sharply higher on its own in February and March as the economy showed surprising strength, shocking bond traders who assumed that a recession was looming--and that yields would continue to fall.

Analysts noted that the first quarter’s losses should be viewed in perspective: The average bond fund gained 15.2% in 1995, with more than half of that in the form of share price appreciation, as market yields tumbled with the slowing economy.

And many economists still believe that the first-quarter spike in interest rates will be reversed later this year. “I think the economy, down the road, is going to justify rates lower than where they are now,” said Louis Crandall, economist at R.H. Wrightson & Associates in New York.

He argues that while the economy has been stronger than expected in recent months, much of that strength stems from the Internal Revenue Service’s faster tax refund schedule this year, putting more cash in peoples’ hands in February. But that will mean fewer refunds in April, and less consumer spending this spring, Crandall says.

Stephen Slifer, economist at Lehman Bros. Government Securities in New York, also predicts that interest rates will fall in the second half of the year with a slowing economy.

Many bond fund managers say the rise in yields has returned the market to a “fairly valued” level, meaning that even if the economy stays on a moderate growth path yields may not need to back up much more. “We don’t see a need to get defensive,” said Tad Rivelle, fund manager at Hotchkis & Wiley in Los Angeles. But he also concedes that the market may still not be prepared for any bad inflation surprises. Wage inflation, in particular, has been creeping higher, Rivelle notes, and further gains could spook bond owners.

For investors who want high yields and who assume the economy could be surprisingly robust, corporate “junk” bond funds may continue to be the smartest bet, some experts say. For investors who want a decent yield with lower risk, funds that own corporate or government bonds in the five- to 10-year maturity range have, over the past five years, delivered returns close to those of more volatile longer-term funds.

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How Bond Funds Fared

Here are average total returns for key categories of bond mutual funds for three periods ended March 29. Total return includes interest earnings plus or minus any change in the bonds’ principal value.

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Average total return Fund category 1st Qtr. 12 mos. 5 yrs. Junk corporate bonds +2.79% +15.0% +92.7% Money market +1.17 +5.2 +21.8 Global money market +1.10 +9.8 +21.0 Adjustable rate mortgage bonds +0.77 +3.6 +22.4 High-quality corporate bonds, 1- to 5-year +0.26 +7.3 +35.3 U.S. govt. bonds, 1- to 5-year +0.14 +6.9 +32.1 Global bonds, long-term -0.36 +12.5 +45.7 Mixed bonds -0.47 +12.6 +62.1 GNMA bonds -1.20 +9.6 +42.9 U.S. govt. bonds 5- to 10-year -1.56 +8.8 +41.6 High-quality corporate bonds, 5- to 10-year -1.74 +9.7 +46.9 General muni bonds, long-term -1.90 +7.2 +44.7 Calif. muni bonds, long-term -2.17 +7.3 +43.5 High-quality corporate bonds, long-term -2.47 +10.2 +50.9 Lower-quality corporate bonds, long-term -2.58 +11.7 +58.4 U.S. govt. bonds, long-term -2.69 +9.3 +42.6

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Note: Muni bond fund returns are understated because interest is tax-exempt.

Source: Lipper Analytical Services Inc.