Whereas the average stock fund has recorded an annualised loss of 6.4%, the average bond fund has gained 5.5% a year and helped cushion the blow of a bear market for equities
Where would mutual-fund investors and the mutual-fund industry be right now without bond funds?
Funds that specialise in bonds and other longer-term debt securities have helped cushion the blow of a bad bear market for stocks. Over the past three years through to the 23 August, the average US bond fund tracked by Bloomberg gained 5.5% a year while the average stock fund suffered an annualised loss of 6.4%.
In 2001 and the first half of 2002, we learn from Investment Company Institute data, bond funds attracted more new money from investors than stock funds for the first time in a decade. In July, stock funds had record outflows of $49bn while $19.2bn poured into bond funds, according to research firm Lipper Inc.'s estimates.
Bonds funds commanded six of the top seven spots on the latest list of best-selling fund categories published by Financial Research Corp. in Boston.
The giant among bond funds, the $61bn Pimco Total Return Fund, managed by Bill Gross, has overtaken Fidelity Magellan Fund as the second-largest long-term US fund. Only the Vanguard 500 Index Fund is bigger.
So is it time to proclaim bond funds the new paragon for the 21st century? Not quite. Though bond funds' share of the total fund business has rebounded from 12% at the end of 1999 to about 15% at mid-2002, by my math, that gives them barely half the 30% share they held at the end of 1993.
As the yield on the US Treasury's 10-year notes dropped in early August to 39-year lows around 4.1%, analysts wondered how much farther falling interest rates and an accompanying rise in bond prices could go. 'Given the pricing, recent returns and popularity of bonds, we expect future returns to be disappointing,'' said Tom McManus, chief investment strategist at Bank of America Securities LLC.
Whatever the ideal place for bond funds in a portfolio, investors are unlikely to find it by shunning them when stocks are hot, then rushing into them when stocks are not. 'Investors should avoid looking at recent performance as a way of setting a personal investment plan,'' says John Brennan, chief executive officer of Vanguard Group Inc in a shareholder newsletter published by the $570bn fund firm.
'Don't focus on bonds because they have performed better than stocks for the past two years.'' Performance chasing is what got many investors in hot water with stocks at the end of the 1990s.
When investors dumped stocks in July only to watch the Standard & Poor's 500 Index rally 22% by late August, they got the same treatment, only in reverse.
Bonds or bond funds are best bought with a long-term purpose: to provide current income, risk-reducing diversification or a combination of those two attributes. The ideal amount to own differs from one investor to the next, depending on age, goals and responsibilities.
When professional investors take cues from what the markets have been doing, they usually resist grabbing what's hot.
They tend to do the opposite, shifting money out of recently strong asset classes into depressed ones.
The idea is to keep stock and bond holdings balanced according to whatever asset allocation plan they're following.
Ed Yardeni, chief investment strategist at Prudential Securities, recently lowered his recommended weighting of bonds for moderate-risk investors from 50% to 40%, while raising his suggested stock weighting from 40 to 50 (the other 10% being in money markets).
'The dramatic drop in bond yields and mortgage interest rates is likely to provide even more stimulus to consumer spending,'' Yardeni said.
At Bank of America Securities, McManus said he has cut his suggested weighting for bonds from 45% to 30%.
However persuasive they may be, the market-timing arguments against bonds are so widely accepted now it can make one suspicious.
Weren't some of these same interest-rate-drop-is-over cries being heard a year ago, when 10-year Treasuries' yield was two-thirds of a %age point higher than its current 4 1/4% level?
For most investors in bond funds, trying to time the credit markets is an impossible mission. As long as you use them strictly for income or diversification, you don't have to be a market-timer to enjoy the comforts and consolations of bonds.
Bloomberg newsroom, New York
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