The Best All-in-One Bond Funds

Our favorites stir in some foreign and domestic bonds to spread your risk and boost your return.
By Elizabeth Ody, Associate Editor

If you didn't own bonds over the past ten years, you missed out. in a decade during which U.S. stocks experienced two major busts, almost every major category of bonds returned at least 6% annualized -- and did so with much less drama. But as with any aspect of investing, the past is not necessarily prologue. And the performance of the past ten years certainly doesn't mean you can invest willy-nilly in any segment of the bond market and expect to do as well over the next ten.

The bond market includes at least a dozen categories, from Treasuries to speculative high-yield corporates to IOUs issued by foreign governments and companies. Most bond mutual funds specialize in only one segment of this vast marketplace. So if you want broad coverage, you might choose to buy a collection of funds -- those that specialize in, say, Treasuries, mortgages and junk, and in short-term and long-term maturities.

But there is another way to cover the bases, and it spares you the guesswork. Some bond funds have the flexibility to invest in any part of the fixed-income marketplace, both here and abroad, in both high-grade and low-quality stuff, and in maturities short, long and in between. Below, we identify five of the best all-in-one funds, sometimes also called multisector funds. Run by some of the brightest bond strategists, these funds are not for the faint of heart. The typical flexible bond fund is two-thirds more volatile than the typical domestic-bond index fund. And because these funds truly can go anywhere in the bond market, their composition may not be the same from one quarter to the next. Still, risk-averse investors should consider holding a multisector fund alongside their high-quality bonds, and the more adventurous could justify putting all their bond money into one or two of these funds.

How much of your portfolio should be in bonds? If you can't stomach a lot of volatility and need current income, you might place all of your investments in bonds. But if you're a long-term investor, we'd encourage you to hold at least 20% to 30% of your assets in stocks. By the same token, even aggressive investors could put as much as 20% of their money in bonds. To help you find the fund that's right for you, we list our picks by the type of investor they're best suited for.

For total return

Dan Fuss and his team at Loomis Sayles Bond (symbol LSBRX) are widely regarded as some of the best bond managers on the planet, thanks to their fund's record of delivering the kinds of returns you expect from stocks over the long term. Fuss and co-managers Kathleen Gaffney, Matt Eagan and Elaine Stokes build the portfolio with a blend of big-picture economic analysis, research on individual bonds and a contrarian's instinct for investing in areas others won't touch.

When the strategy works, it produces solid results. But when other bond funds scrape their chin, Loomis gets a concussion. In 2008, for example, the team was far too early in anticipating a recovery in low-quality corporate bonds. As a result, the fund dropped 22% that year (compared with an average loss of 16% for multisector funds).

But since then, Loomis Sayles Bond has more than made up for lost ground. It soared 37% in 2009, and its 8.6% annualized return over the past ten years beats more than 90% of its peers (all returns are through December 31; see our bond-fund and bond-ETF tables for more data).

Recently, the fund's managers have grown cautious. Fuss believes that the U.S. is at the start of a long-term rise in interest rates, so the managers are gradually trimming the fund's average maturity to lessen its susceptibility to higher yields. The team also favors debt denominated in so-called commodity currencies, such as the Canadian and Australian dollars, which tend to move in tandem with commodity prices and can provide a hedge against both inflation and a sinking dollar (see Make a Buck Off a Sagging Dollar).
For interest-rate bears

Fuss and colleagues aren't alone in their concern that rising interest rates will erode bond returns over the next few years (bond prices move inversely with rates). Trimming maturities is one way of minimizing this risk. But Chris Dialynas, manager of Pimco Unconstrained Bond (PUBDX), has the flexibility to go a leap further by effectively seeking to make money from rising rates. The fund's prospectus allows him to position it in such a way that Unconstrained Bond could gain as much as 3% if interest rates were to rise one percentage point.

That's not to say the fund is a one-trick pony. The members of Pimco's lead strategy team, including Dialynas and Pimco's chief investment officers, Bill Gross and Mohamed El-Erian, generate the investment ideas that populate this and other Pimco funds. Pimco Unconstrained Bond will tend to reflect the same bets as flagship Pimco Total Return but in a more concentrated, more aggressive fashion. The only significant constraint on Dialynas is that the fund must maintain an average credit quality of at least triple-B, meaning he can't go overboard on junk bonds.

That's just as well, because Dialynas believes that junk prices today reflect an overly rosy view of the economy and corporate profits. He also thinks chances are good that the Federal Reserve's easy-money policy will eventually stoke inflation. In that case, his flexibility on interest rates could come in awfully handy.
For income

Next to Dan Fuss's nearly two decades at Loomis Sayles, Steve Huber's one-year tenure at T. Rowe Price Strategic Income (PRSNX) appears unimpressive. But Price has a superb record as a bond manager -- of its 11 taxable-bond funds that have been around at least ten years, nine have beaten the average return of their peers over the period. Four other Price sector experts join Huber on the team that determines the fund's allocation to different bond classes. Picking individual bonds then falls to teams of specialists.

Today, says Huber, "we're in more of a coupon-clipping environment" than in 2009, when rapidly ascending bond prices generated handsome double-digit returns in many sectors. He's relatively bullish on corporate bonds, figuring that many companies have cut costs and refinanced their higher-yielding debt, making it easier for them to meet current obligations. Huber is paring back exposure to mortgage bonds, in anticipation of the U.S. Treasury halting its mortgage-purchase program at the end of the first quarter of 2010.

As many a Jackson Pollock wannabe has sadly discovered, our brains' creative juices tend to flow far better when we operate within a framework of constraints as opposed to working with unfettered creative liberty. Perhaps our minds also need limits when making investing decisions. That might help explain the bang-up record at Fidelity Strategic Income (FSICX), whose managers work within rigid rules governing the fund's makeup.

Strategic Income is shaped like a barbell, with assets split between risky and safe issues. Lead managers Joanna Bewick and Chris Sharpe begin with a neutral allocation of 30% U.S. government debt, 15% developed-market government debt, 40% U.S. junk bonds and 15% emerging-markets debt. "We don't compromise by buying anything in the middle," Bewick says. Although that restriction means the fund can miss out on attractive opportunities, she says, "it makes for simplicity and clarity of decision-making."

Bewick and Sharpe tweak the allocations to adjust to market conditions and then leave the selection of individual bonds to Fidelity specialists. Ordinarily, Bewick and Sharpe don't shift the fund's mix between "safe" and "risky" assets by more than a few percentage points, but when the market calls for a bold move, they can oblige. For example, the team began shifting toward safe U.S.- and foreign-government bonds at the start of 2007, before subprime had become a household word. That allotment peaked at 60%, or 15 percentage points above the neutral weighting, in September 2008, helping to contain losses that year to 11.4%. Lately, the fund is close to its neutral allocations, with a bearish stance on U.S.-government debt and a bullish stance on junk bonds.

For extra spice

Carl Kaufman and Simon Lee arenUt bound by any explicit constraints in managing Osterweis Strategic Income (OSTIX). But they self-impose one rule: Buy what you know. So they usually avoid mortgages and bonds denominated in foreign currencies, the two areas they feel ill-equipped to judge. Because Kaufman is a former convertible-bond specialist, he and Lee tend to keep a significant portion of assets (15% to 40%) in converts. These are bonds that can be converted into a set number of the issuer's common shares and that will behave like bonds or like stocks at different times.

The managers begin their process by taking a 10,000-foot view of the bond market and the economy, seeking to identify the greatest risks for bonds. "Over the next couple of years, that risk is probably rising interest rates," Kaufman says. Then they look for attractively priced bonds that are likely to hold up against that risk. And that's leading them to buy short-term, high-yield bonds and convertible bonds that can be redeemed with the issuer for a set price within the next two to four years.

With its heavy bias toward convertibles and ordinary corporate bonds, Osterweis isn't as diversified as the other funds on this list. But its record suggests that it's worthy of your attention anyway. From its inception in 2002 through December 31, the fund returned 8.2% annualized, or two percentage points better than the average flexible bond fund, with one-third less volatility.
Three moves to make now

Use this checklist to give your bond portfolio a tune-up.

Allocate. Bonds have performed far better than stocks over the past few years, so your bond holdings may have appreciated beyond your target weighting. Adjust as necessary.

Diversify. Don’t just sit on Treasuries. Diversify with one or two of the funds recommended in this story, or fill in the gaps in your bond portfolio with the exchange-traded funds described on the next page.

Strategize. The linked forces of rising interest rates, inflation and a falling dollar threaten to eat away at your bond returns over the next several years. Keeping maturities short will help insulate you from rising rates, while owning some bonds denominated in foreign currencies can help protect you from the two other developments.


From kiplinger's Personal Finance Magazine, March 2010

TREASURIES-Bonds dip on better jobs picture

* Prices slip on eve of May employment report

Bonds

* Fed's Bernanke says high unemployment remains a concern

* Treasury to sell $70 bln 3Y, 10Y, 30Y supply next week (Updates comment, market action, changes byline)

By Ellen Freilich

NEW YORK, June 3 (Reuters) - U.S. Treasury debt prices fell on Thursday as the stock market edged higher and traders cut holdings of safe-haven government bonds in anticipation of a robust May payrolls report on Friday.

Stocks were in the minus column for much of the session but crept into positive territory late in the day, and bond prices fell as the safety bid waned and investors took on riskier assets.

"When stocks fell, Treasuries rebounded, and when stocks moved up, Treasuries headed lower, but the bond market's overriding consideration was positioning for Friday's report on May U.S. job growth, which is expected to be quite strong," said John Canavan, analyst at Stone & McCarthy Research Associates in Princeton, New Jersey.

Benchmark 10-year notes US10YT=RR fell 7/32 in price to 101-3/32. Their yield, which moves inversely to price, rose to 3.37 percent, up from 3.34 percent on Wednesday.

Some U.S. labor market data released this week appeared to support expectations for a robust half-a-million increase in jobs in the government's payrolls report due on Friday.

A report from ADP Employer Services on Thursday said U.S. private employers added 55,000 jobs in May and an upwardly revised 65,000 in April. For more, see [ID:nEAP102300]

The Institute for Supply Management reported its labor gauge of U.S. services industries rose, with its employment index at its highest level since December, 2007, while the government said U.S. claims for initial jobless benefits fell moderately last week. [ID:nEAP101300] [ID:nOAT004637]

The median May job growth estimate culled from a Reuters poll of economists was 513,000, after 290,000 new jobs were added to payrolls in April.

"The labor market appears to be on the mend," said Joseph LaVorgna, chief U.S. economist at Deutsche Bank Securities in New York. LaVorgna estimated that U.S. non-farm payrolls expanded by 600,000 jobs in May, about two-thirds of which would be due to temporary Census hiring.

His noted his forecast for private sector job creation of 200,000 is actually slightly weaker than April private sector job growth of 231,000.

"Heightened economic concerns last month related to financial market gyrations and sovereign risks may have caused some employers to postpone hiring they might otherwise have done in May," he said.

LaVorgna said the change in private payrolls would matter most to policymakers, and that the Federal Reserve needs to see "a steady string" of monthly payroll gains topping 300,000, excluding temporary Census workers.

Traders said if private sector hiring comes in stronger than people expect, Treasuries could succumb to further selling, especially ahead of new supply next week.

"We would have a reason for equities to run up and bonds to sell off," said Justin Hoogendoorn, managing director of U.S. fixed income at BMO Capital Markets in Chicago.

Still, even as the economy has started to produce new jobs, unemployment is stuck at a high level, which remains a top concern for the Fed policy-makers.

Fed Chairman Ben Bernanke told a small business group in Michigan that the jobless rate, which was at 9.9 percent in April, is a "particularly difficult issue." [ID:nWAL3HE67L]

Benchmark yields touched two-week highs on encouraging jobs data and stocks rose briefly on lessened anxiety over Europe's sovereign debt crisis.

"Players continue to watch the euro as a measure for the broader outlook for the European economy, but it hasn't been doing much for days," Canavan said. "It's near its recent lows, but it has settled into a range in recent days."

Traders also eyed the supply coming to market next week.

The U.S. Treasury said it will sell a combined $70 billion of coupon-bearing securities next week: $36 billion of three-year notes, $2 billion less than in May, as well as reopened issues of 10- and 30-year securities.

The government began paring the auction sizes of shorter-dated debt in May, partly because tax receipts have increased in recent months. (Additional reporting by Richard Leong; Editing by Chizu Nomiyama)

From  REUTERS published on Thu Jun 3, 2010 5:09pm EDT

Bonds: Avoid the next great bubble

By Paul J. LimJune 4, 2010: 4:46 AM ET

(Money Magazine) -- As manias go, this one is different. Your neighbors aren't coming up to you at cocktail parties bragging about making a killing in bonds. No one is flipping fixed income for quick profit. And no talk-radio guru is shouting that bonds will be the only investment left standing after the next financial Armageddon.

Don't let the lack of fanfare fool you. A projected $380 billion will pour into bond funds this year, more than went into domestic stock funds in the past decade. That's on top of a record $376 billion last year.

"The bond market is a bubble," says Robert Froehlich, senior managing director of the Hartford Financial Services Group. "And it's getting ready to burst." One major reason: Despite the recent rally in treasury bond prices and slide in yields -- due to fears over the European debt crisis -- the long-term direction for interest rates is headed higher.

What's inflating the bubble

Like all financial manias, this one is being fueled by a combination of fear and greed.

James Stack, a market historian and president of InvesTech Research, notes that many baby boomers who have stampeded into bond funds did so in reaction to their stock losses since the financial crisis began in 2008.

"It's post-traumatic shock," he says. Even with the rebound in equities since March 2009, "investors fear putting money into the stock market because they have a newfound respect for the risk equities pose."

Over the past decade, holding bonds was considerably safer than holding stocks. After the tech bubble burst in 2000 and equities lost almost half their value over the next three years, corporate bonds surged nearly 50%. And when the global financial crisis erupted two years ago, U.S. Treasury bonds were just about the only investment to retain value. The flight to safety in recent weeks, driven by concerns over Europe's mounting budget problems, has moved investors back into treasuries for the time being yet again.

On top of that, few investors know what it's like to live through a true bear market in bonds. Fueled by falling interest rates (long-term rates were as high as 15% in the early '80s), the current bull market has lasted for 30 years.

The resulting sense of safety -- the belief that bonds don't go bad -- is contributing to this feeding frenzy in fixed-income funds and ETFs. And all that money flowing in has made bonds very expensive.

You can see how frothy Treasuries are by calculating a P/E of sorts for bonds; just divide the bond's price by its current yield, not by earnings. At a price of around $100 and a yield of 3.3% -- up from 2% in december 2008 -- 10-year Treasurys have a P/E of 30. That's around twice their historical level.

It's true that bonds are less volatile than stocks. But in fact they lose money just as often as equities do. "I don't think the public understands they can lose money in bond funds," says James Swanson, chief investment strategist at MFS, an asset-management firm in Boston.

So that's the fear part. The greed part comes from an entirely different group of people: safety-loving folks who normally park their money in cash, such as bank savings accounts, CDs, or money-market funds. Fed up with the meager interest rates those accounts are paying these days -- the average taxable money-market fund yields 0.03% -- they're venturing into short-term bond funds to eke out a bit more yield.

Why the bubble could burst

One part of the bubble is already leaking air: long-term government bond funds. Because they invest in supersafe U.S. Treasuries and other forms of government-backed debt, they were a popular place to hide during the mortgage meltdown.

But when the economy began improving and rates on 10-year Treasurys began rising (from about 2% at the end of 2008 to as high as 4% in April before slipping to 3.3% today), these funds started suffering. In fact, the Vanguard long-term Treasury bond fund fell 12% in 2009 and, despite the recent run up in Treasury securities, is still down 5% since the end of 2008.

Experts say that's just the beginning. Here are the major factors that could harm bonds further.

Rising interest rates. "Rising rates are the biggest concern out there for bonds," says Mario De Rose, fixed-income strategist for the brokerage Edward Jones in St. Louis. That's because they make older, lower-yielding bonds that you or your funds own look less attractive compared with newer securities.

Let's say you bought a 10-year Treasury at the current rate of 3.3%. If rates rose to, say, 4.3%, the price of the bond would fall by nearly 8%, according to T. Rowe Price. So even though you'd be earning interest income, your actual total return would be 4%.

Alas, even if rates continue to tick down for a bit, the long-term trend is up. Economists at Standard & Poor's think the yield on 10-year Treasuries will jump to 5.3% by 2012; Froehlich of Hartford predicts it could hit 6.5% much sooner than that.

In a rising-rate environment, individual bonds have an edge over bond funds. You can simply hold individual bonds to maturity, at which point the issuer promises to give you back your original investment in full. That's impossible with funds, which hold lots of issues and are constantly buying and selling. Fixed-income funds can still make sense for a lot of reasons. But "they are the worst investment when it comes to rising rates," says InvesTech's Stack.




The return of inflation. Even individual bonds are no match for the power of an overheated consumer price index. Bonds tend to do well in periods of falling, not rising, inflation. From 1980 to the end of 2009 -- when the annual growth in the consumer price index fell from nearly 14% to virtually nil -- bonds delivered higher-than-average returns of nearly 10% a year, according to Ibbotson Associates.

With the federal deficit now projected to exceed $1 trillion this year and next, the Federal Reserve has little choice but to effectively crank up the amount of money in circulation. So there's a real chance that inflation -- nonexistent now -- could start running as hot as 5% in the next few years. If that happens, the real return on any bond yielding below 5% would be wiped out entirely.

Lingering doubts about the economic recovery. Most experts believe that the global economy is on the mend. But ongoing struggles in the housing market, a rise in mortgage defaults among owners of commercial properties, or a spread of the debt crisis in Europe are still possible, says Jeremy Grantham, chief investment officer of GMO, an asset-management firm in Boston. Any of those could damage the financial health of the countries or companies that issue bonds.

If investors become concerned that certain bond issuers are less creditworthy, their debt will become less desirable, weighing down bond prices. For example, thanks to growing worries about the debt crisis in Greece, Spain, and Portugal, many funds that specialize in European bonds are down so far this year. American Century International Bond, with around two-thirds of its assets in debt issued from European countries, has fallen more than 7%.

Panic selling. In today's low-rate environment, some bond fund managers -- even those who run short-term funds -- are taking extra risks "to reach for extra yield," says Russel Kinnel, director of fund research for Morningstar.

For instance, they might invest in bonds issued by entities of questionable financial health. The results aren't always pretty. In 2008 several short and ultrashort funds posted staggering losses (35% in the case of Schwab YieldPlus) as the credit crisis crushed bonds that they held.

Remember all those Johnny-come-latelies who recently moved from money-market funds to bond funds? At the first sign of trouble, many of them are likely to flee back to cash, warns Marilyn Cohen, president of Envision Capital Management, an advisory firm in Los Angeles that manages bonds for individual investors.

If the selling is severe enough, fund managers could be forced to dump bonds to meet redemptions, making other bond investors' losses worse. That risk is especially high with bonds that trade infrequently. Holders might accept fire-sale prices to get out in a hurry -- that rush to sell exacerbated losses suffered in the credit crisis.

How to protect yourself

Does this mean you should junk your bond holdings? No. If used properly, bonds will help you diversify your portfolio and generate much-needed income. Instead, try these strategies to protect yourself from the worst effects of a bond meltdown.

Shorten your durations. "Duration" measures how sensitive an investment is to interest rate changes. If a bond or bond fund has a duration of five years, for example, its price is likely to rise around 5% if interest rates fall by one percentage point. Conversely, if rates rise by one point, the price will fall by around 5%. The longer the duration, the higher the risk of losses. In this rising-rate environment, MFS's Swanson advises investors to stick with durations of around four years or less.

If you own a long-term government bond fund, consider replacing it with a shorter-term one with a duration in Swanson's target zone. Also check out the duration of the intermediate- and short-term funds you already own. You can do so by going to Morningstar.com, typing in your fund ticker, and clicking the Portfolio tab.

There can be significant variation within categories. While the average duration of a typical intermediate-term government bond fund, for example, is about four years, that of Managers Intermediate Duration Government (MGIDX).



  

Buy TIPS rather than regular Treasuries. Treasury Inflation-Protected Securities yield significantly less than regular Treasury bonds right now (around 1.3% for 10-year TIPS vs. 3.3% for regular Treasuries of similar maturities). But TIPS have one big advantage: The interest they pay is adjusted to reflect changes in the consumer price index.

Jason Brady, a managing director at Thornburg Investment Management in Santa Fe, points out another plus. When interest rates rise (which is typical during periods of higher inflation), demand for TIPS is likely to be stronger than for plain-vanilla Treasuries. That means TIPS' prices are unlikely to fall as far.

These days it makes sense to buy individual TIPS rather than mutual funds that hold them. For one thing, it's easy to buy the bonds directly from Uncle Sam at Treasurydirect.gov. You'll pay no commissions or other fees. And the minimum investment is just a hundred bucks. As for maturity, choose one of no more than 10 years. And make sure you won't need the principal back before the end date.

Shift some short-term money to floating-rate bank funds. These funds invest in short-term, adjustable-rate bank loans made to corporations. Because such loans often reset every one to six months, "you get more income as rates rise," says Brady. The average bank loan fund has returned around 3% so far this year, compared with 2% for the average short-term bond fund.

But banks make many of these floating-rate loans to companies with less-than-pristine balance sheets. Stick with funds that focus on more creditworthy companies, such as those whose debt is rated BB -- just a couple of notches below "high quality" -- or above. One example: Pioneer Floating Rate (FLARX). Check a fund's credit quality at Morningstar.com.

Raise the credit quality of your munis. Battered municipal budgets will improve eventually, assuming the economy continues to heal. But historically, states and cities are among the last financial entities to emerge from a downturn. "I am not worried about credit risk among corporations, but I am worried about it in the muni space," says Envision Capital's Cohen.

To lower that risk, go with funds that invest mostly in municipal bonds rated AA or higher, like Fidelity Intermediate Municipal Income (FLTMX).

Lower the credit quality of your corporates. Move some of your corporate bond stash to high yielders. That's right: junk bonds.

This strategy isn't as crazy as it sounds. Junk bonds aren't as sensitive to rising rates as investment-grade bonds are, in part because their higher payouts provide a cushion if bond prices start to fall. In the past three periods when rates rose -- 2005, 1999, and 1994 -- high-yield bonds outperformed Treasuries by an average of 10 percentage points, according to an analysis by T. Rowe Price.

Moreover, if rates are rising because the economy is improving, demand for these bonds will climb. "A small positive change in the economy could have big changes in the fundamentals of these types of companies and their ability to pay back their debt," says Carl Kaufman, manager of the Osterweis Strategic Income fund.

That said, if investors fear the economy is headed into another storm -- as was the case in recent weeks -- high-yield funds could sink along with the broad stock market. In fact, the average high-yield fund has fallen nearly 4% over the past month (though it's still up more than 25% over the past year).

Given that the global economy hasn't fully recovered, stick with relatively conservative high-yield funds that avoid companies with the ugliest balance sheets. One such fund is Vanguard High-Yield Corporate (VWEHX). The typical bonds in this fund are issued by companies with ratings of BB or higher.

Don't give up on foreign bonds. The recent Greek tragedy may have you wondering if it's time to repatriate your entire fixed-income portfolio. Resist the urge.

As we've mentioned, Greece's debt problems have hurt the price of government bonds from Portugal and Spain. (Long-term Greek bonds now yield more than 8%, a reflection of how risky they are.) But those from many other European countries, including Germany and Britain -- whose government bonds yield almost exactly what U.S. Treasuries do -- have held up decently.

You should be looking beyond just Europe anyway. It's smart to diversify your fixed-income stake around the world because interest rates in different regions are expected to climb at different rates.

Another plus: If rates rise because of hotter inflation as expected, bonds from commodity-driven countries such as Australia, Brazil, and Canada will do well, says Thornburg's Brady. At the very least, they're highly unlikely to spoil your portfolio. To top of page

   
From CNNMONEY.COM Posted on June 04, 2010