Bond Funds Perform Best in 4th Quarter

Bond mutual funds, back in vogue on Wall Street after a long hiatus, performed better than most stock funds in the fourth quarter as investors’ focus turned toward safety and away from risk-taking.

Bond funds’ total returns--interest earnings plus or minus any change in principal value--were mostly in the 1.3% to 3% range for the quarter, according to fund tracker Lipper Analytical Services’ quarterly tally.

By contrast, the average U.S. stock mutual fund lost 1.6% in the quarter, Lipper said.

For the full year, however, bond funds’ total returns were mostly in the 8% to 9% range, while the average stock fund gained 24%.

Bond funds’ returns in 1997 were vastly better than in 1996, when rising market interest rates cut into the funds’ principal values. In 1997, as rates began to tumble in the fourth quarter, principal gains helped boost the funds’ returns.

The typical fund that owns long-term U.S. government bonds, for example, had an annualized interest yield of 5.8% as of Dec. 31. But the average total return of such funds for the year was 8.8%. The additional return, above the interest yield, was principal gain as falling market interest rates made older, higher-yielding bonds more valuable.

As rates have fallen, funds that own the longest-term bonds naturally have performed best.

General municipal bond funds, for example, had an average total return of 2.79% in the fourth quarter and 9.1% for the year.

Funds that own high-quality long-term corporate bonds also performed well overall, gaining 2.71% in the quarter and 9.2% for the year, on average.

But in a clear sign that investors have grown worried about the U.S. economy’s outlook, funds that own junk corporate bonds--the lowest-quality corporate issues--gained just 1.27% in the quarter, on average. Their return for the year still was the best of any major bond fund category, however, at 12.9%--thanks mostly to the high yields the bonds pay.

For 1998, many bond pros believe that higher-quality bonds will continue to lead in performance, while more signs of economic weakness could hurt the junk sector by raising default risks. Many pros also warn that funds focused on mortgage bonds, such as GNMA issues, could be hurt by worries about rising bond prepayments if more homeowners refinance.

To learn more about bonds and mutual funds, attend the Los Angeles Times’ Investment Strategies Conference, Feb. 7-8 at the Los Angeles Convention Center. For information or to register, call (800) 350-3211.

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How Bond Funds Fared

Here are average total returns for key categories of bond mutual funds for the fourth quarter and for all of 1997. Total return includes interest earnings plus or minus any change in the bonds’ principal value. Also shown is the average fund yield in each category at Dec. 31.

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Fund category 4th Qtr.** 1997** Avg. yield U.S. govt. bonds, long-term +3.01% +8.8% 5.8% General muni bonds,long-term* +2.79 +9.1 4.7 High-quality corporate bonds, long-term +2.71 +9.2 5.9 Lower-quality corporate bonds, long-term +2.57 +10.1 6.2 U.S. govt. bonds 5-to 10-year +2.48 +8.1 5.7 High-quality corporate bonds, 5- to 10-year +2.38 +8.6 5.8 GNMA bonds +2.21 +8.8 6.1 U.S. govt. bonds, 1- to 5-year +1.41 +5.8 5.4 High-quality corporate bonds, 1- to 5-year +1.38 +6.2 5.8 Junk corporate bonds +1.27 +12.9 8.4 Money market +1.23 +4.9 4.8 Mixed bonds +0.44 +8.7 7.4 Global bonds,long-term --0.07 +3.0 6.2

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* Because muni yields are tax-exempt figures understate true returns

** Total return

Source: Lipper Analytical Services Inc.