Bond fund balance
NEW YORK – With some investors wringing their hands about inflation and the Federal Reserve’s efforts to keep it in check, those with bond fund holdings could be forgiven for wanting to take their money and run. But while some market observers see volatility ahead, few are ready to call it quits.
“I would say things are going to get a little bumpy here in September for the bond market, but I don’t think it’s the end of the world,” said Jeff Tjornehoj, a senior analyst at Lipper Inc. He contends there are still smart plays to be made.
Bonds have faced a more difficult environment in the past two years as the Federal Reserve raised interest rates 17 straight times before pausing last month. While the rate increases hurt bond funds, leaving some investors wary, sentiment changed in late June when Fed comments led investors to believe the rate increase had come to an end.
Bond prices move in the opposite direction of their yield. So as interest rates rise, the prices of bonds often fall because investors refuse to pay as much for a bond that has a lower yield.
“Investors are saying that the Fed is done raising rates and so that’s why you see people taking more risk now,” said Jim Kauffmann, head of fixed income at ING Investment Management. He noted that it became more acceptable to take risk in areas such as high-yield bonds, which have lower credit-quality ratings.
Kauffmann said the Fed’s comments turned investors’ attention to growth from inflation, with the notion that if growth in the economy moderates then so too will inflation. “Now that’s a huge leap of faith for investors to make,” he said.
Still, Kauffmann believes that if interest rates hold, bond funds should have an easier time showing the returns investors are looking for.
The amount of money invested in bond funds is about $1.41 trillion, or about 15 percent of the amount invested in mutual funds overall, according to the Investment Company Institute, the mutual fund industry trade group. Displeased with lackluster returns for intermediate to long-term bonds, investors snipped their bond fund holdings in 2004 after having added since 2001.
But the funds saw renewed interest last year, with investors pumping $31.3 billion into the sector, according to ICI.
This year has seen a mixed performance for bond funds, with many of the year-to-date gains occurring in the three months since investors interpreted that the Fed was done raising interest rates.
A cautious investor will likely be more comfortable investing in funds focused on shorter-term bonds, not those whose focus is bonds with 10- and 15-year maturities, said Steve Schoepke, vice president of research and product development at AIG SunAmerica Asset Management. Still, he said, investors shouldn’t necessarily shun longer-term maturities. He prescribes diversification and, as an example, offered up a “barbell” approach, in which an investor’s holdings are a mix of short-term and long-term maturities with few intermediate-term bonds.