Now May Be a Good Time to Look at Bonds, Some Pros Argue

With Treasury bond yields near 20-month highs, the corporate bond market glutted with new issues, a swooning dollar and all eyes on newly hawkish Federal Reserve Chairman Alan Greenspan, these are nervous days for fixed-income securities.

Which is exactly why some professionals think now may be a good time to begin buying--especially if you’re an investor who has largely ignored bonds in the 1990s in favor of stocks.

The yield on the benchmark 30-year Treasury bond has climbed to 6.12% as of Monday from 5.09% at the end of January.

Yields on corporate junk bonds--those issued by high-risk companies--have risen to their highest levels since November. An index of 100 junk bonds tracked by KDP Investment Advisors rose to 10.08% on Monday, up from 9.1% in late April and the highest since Nov. 9.

Investors have been demanding greater yields even from top-quality companies. The average yield on an index of 20-year investment-grade corporate bonds tracked by Moody’s Investors Service now is about 1.5 percentage points above the 6% or so that 20-year Treasury bonds yield.

That’s the widest “spread” between those yields all year.

“Sentiment is so negative. Everybody seems to hate bonds,” said David MacEwen, who heads the California municipal bond group at American Century Funds in Mountain View, Calif.

For many investors who already own bonds or bond mutual funds, this year is a money-loser. Rising market yields mean older fixed-rate bonds are falling in value, in effect negating interest earned.

But as yields climb, they’re also presenting an opportunity for investors who want to lock in fatter returns.

Indeed, MacEwen has noticed that investors whose full attention was on the soaring stock market in recent years have begun eyeing bonds.

With the major stock market indices down 5% to 8% from their recent highs, and with once-highflying Internet stocks off 25% or more from their April peaks, the concept of risk in the equity market is reintroducing itself.

“We say to people: ‘You played the [stock-market] game. You won. Why not take some chips off the table?’ ” he said. “That message fell on deaf ears for a long time,” he added, but people are starting to listen, particularly since long-term Treasury bond yields have pierced the 6% barrier again.

Of course, there are near-term risks in the bond market as well.

The main force driving yields upward is the Fed’s apparent willingness to take preemptive action against inflation. Greenspan and his fellow central bankers have been warning that inflationary pressures are present in the tight job market and elsewhere.

“Greenspan has made clear that they’ve got their finger on the trigger” to raise short-term interest rates further, said Marilyn Cohen, a fixed-income specialist at Envision Capital Management in Los Angeles.

The Fed made its first move June 30, raising its benchmark short-term rate from 4.75% to 5%.

Market players will be watching economic statistics, such as Friday’s July employment report, to try to get an early read on what the Fed might do at its Aug. 24 policy meeting.

On the other hand, bond owners are professional pessimists, Cohen notes. “We’ll say it’s never a good time to buy,” she said. “We’re always worrying about the next number, the next event.”

Yes, yields could rise a lot higher if inflation should soar amid a dramatic pickup in world economic growth. But with yields already having rebounded sharply, many experts say investors who’ve been thinking about buying and holding bonds--locking in a fixed yield for a set term--ought to start nibbling.

Making a bond investment can be as simple as buying a five-year Treasury note via a discount broker. They now yield about 5.8%--far better than what most five-year bank CDs are paying.

For investors who have the wherewithal, the best choice is to buy individual bonds, Cohen said. She advises buying intermediate-term issues, maturing in nine to 10 years, because they offer yields nearly as good as 20- or 30-year bonds and with much lower risk.

In particular, Cohen likes corporate securities such as bonds issued by Lehman Bros. Holdings, Time Warner Inc. and Seagram Co., all of which tend to carry “triple-B” ratings from Moody’s.

That puts them in the lower end of the investment-grade category, but Cohen said the extra risk pays off in yields of up to 2 percentage points above those of 30-year Treasuries.

Typically, you’d need a broker’s help in buying individual corporates. It’s worth it: You don’t want to buy a bond that may be “called,” or paid off early.

Other options, Cohen says, include closed-end bond mutual funds trading below their net asset values, and “unit investment trusts,” which hold bonds to maturity, paying out their proceeds as the bonds mature.

Although they often have high sales fees, UITs can be good ways to lock in yields. Mutual funds, by contrast, may constantly shift their portfolios, so your interest yield isn’t necessarily fixed.

Mario DeRose, bond strategist at brokerage Edward Jones in St. Louis, agreed that higher yields on high-grade corporate bonds make them a better buy than Treasuries.

Although there may be bumps in the bond market over the next few weeks and months, DeRose believes that rates will be lower a year from now, making this a good time to get in.

As worrisome as another Fed rate increase may seem, the central bank’s hawkishness is actually a positive, he said. The Fed is “out to prove they’re ahead of the [inflation] curve, and that’s good news for bond buyers, because inflation kills bonds” if allowed to soar.

Unlike late last summer, when corporate bond yields rocketed amid the Russian debt default and Asian economic woes, analysts say, the surge in yields this time reflects both the Fed and a rush of new-bond issuance.

Specifically, there has been a flood of corporate bond issues this summer, largely because of concerns about the year 2000 computer problem, or Y2K.

Thomas G. Doe, president of Municipal Market Advisors in Concord, Mass., said that regardless of whether they think Y2K will cause computer and communications disruptions, corporate treasurers firmly believe that institutional buyers will be sitting on the sidelines in December just in case. So firms are rushing their issues to market now--and they’re paying more to do so, Doe said.

MacEwen, the California municipal bond expert, noted that high corporate yields are attracting some institutions--insurance companies, pension funds and the like--that normally would be buying tax-free municipal bonds.

This “crossover” buying is at least one factor pushing muni rates upward as well, he said.

California municipals, which are federal and state tax-free to California residents, are offering particularly attractive yields in longer maturities, MacEwen said.

Individuals tend to buy munis with maturities of 10 years or less, he said. But 15-year California munis are yielding an average of 5.25%, compared with 4.75% for 10-year bonds. That extra half-point is an unusually rich payoff for investors willing to accept the longer term, MacEwen said.

MacEwen recommends buying insured bonds, arguing that individuals seldom have the time or expertise to fully investigate a municipality’s credit-worthiness.

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Snapping Back

Bond yields hae risen across the board this year. Here is the average yield on an index of high-yield junk corporate bonds, monthly closes and latest:

Oct. 19998: 10.41%

Monday: 10.08%

Sources: KDP Investment Advisors, Bloomberg News

A Sampling of Bond Fund Ideas

Here are some highly ranked bond mutual funds, as rated by fund tracker Morningstar Inc. We list a few funds each in three categories: high-yield junk bond funds, high-quality corporate bond funds and government bond funds. Shown are each fund’s total return--interest income plus or minus any change in principal value--for three periods ended July 30: year to date, the last year and the last five years. The five-year figure is annualized. Also shown are the funds’ 12-month interest yields as of June 30. For more information on this list, see the sidebar at left:

HIGH-YIELD BOND FUNDS

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Total investment returns: 12-mo. Fund YTD 1-yr. 5-yr. yield Mainstay High-Yield Corp. Bond B 7.6% 3.1% 11.0% 9.0% American High-Income 4.8 0.4 10.0 9.0 Federated High-Income Bond A 2.6 -0.4 10.1 9.1 Invesco High-Yield 6.3 -0.8 10.8 9.3 Northeast Investors 4.7 -1.9 10.6 9.2 Average high-yield fund 3.1 -2.6 8.5 9.4

800 phone Fund number Mainstay High-Yield Corp. Bond B 624-6782 American High-Income 421-4120 Federated High-Income Bond A 341-7400 Invesco High-Yield 525-8085 Northeast Investors 225-6704 Average high-yield fund

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HIGH-QUALITY CORP. BOND FUNDS

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Total investment returns: 12-mo. Fund YTD 1-yr. 5-yr. yield FPA New Income 3.8% 4.4% 7.4% 6.2% Pimco Total Return -1.5 3.6 8.1 5.9 Vanguard Total Bond Mkt. Index -1.8 2.4 7.2 6.2 Dodge & Cox Income -1.7 2.3 7.6 6.0 Average general bond fund -1.3 1.9 6.3 5.7

800 phone Fund number FPA New Income 982 -4372 Pimco Total Return 927-4648 Vanguard Total Bond Mkt. Index 662-7447 Dodge & Cox Income 621-3979 Average general bond fund

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GOVERNMENT BOND FUNDS

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Total investment 800 returns: 12-mo. phone Fund YTD 1-yr. 5-yr. yield number Vanguard Short-Term Federal 0.4% 4.0% 6.1% 5.7% 662-7447 Strong Government Securities -1.5 2.4 7.2 5.5 368-1030 U.S. Government Securities -2.2 2.2 6.1 6.2 421-4120 Merrill Lynch Fed. Sec. D -0.8 2.0 6.3 5.6 637-3863 State Street Res. Govt. Inc. A -2.7 1.9 6.8 6.1 882-0052 Average government bond fund -1.7 1.9 6.0 5.5

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Source: Morningstar Inc.