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In Search of Bond Bargains

January 05, 2009 | “The Wall Street Journal"

After a rough 2008, bond-fund investors may find bargains for 2009 -- if they're daring.

Last year challenged a lot of perceptions about these supposedly conservative holdings. Several fixed-income fund categories were down by unprecedented levels. Among the worst: High-yield, or "junk," bond funds lost 26% on average, according to research firm Morningstar Inc. Bank-loan funds were down 27% -- their first calendar-year loss since Morningstar began tracking them in 1990.

"It was an absolutely brutal year" for most bond investors, says Morningstar analyst Lawrence Jones. Bond prices tumbled as investors anxious about the economic slowdown dumped corporate bonds and other obligations that carry the risk of default. "Anything that smacks of credit risk has been horribly hit," Mr. Jones says. By contrast, Treasury securities and the funds holding them delivered strong returns as investors bid up the prices of these safe havens.

Down the road, if investors in the marketplace become more comfortable bearing credit risk, the prices of many bonds and bond funds may bounce back -- helping bond-fund investors recover some of the ground they've lost.

And while it may be cold comfort for those nearing retirement, the steep bond-market declines mean there could be big bargains for those with fresh cash to invest now. Experts say all kinds of bonds are trading at fire-sale prices.

Here's a look at how several bond-fund sectors fared in 2008 -- and how they're poised for 2009.

INTERMEDIATE-TERM BONDS. This is Morningstar's largest bond category and a good place to look for a core bond fund for your portfolio. It's also something of a catchall, encompassing funds that own plain-vanilla investment-grade corporate debt as well as others that have broader mandates allowing them to take bets on everything from Treasurys to asset-backed securities.

Intermediate funds delivered an average return of negative 4.9% in 2008 (reflecting both price change and interest earnings), but returns varied widely. One standout, Old Westbury Fixed Income, which recently had more than three-quarters of its holdings in Treasury and agency bonds, finished the year up 11%. Others posted big losses. The worst performer, Regions Morgan Keegan Select Intermediate Bond, lost more than 80% after it misjudged bets on mortgage-backed and asset-backed securities.

A spokeswoman for the fund's distributor, Regions Financial Corp.'s Morgan Keegan unit, declined to comment. A spokeswoman for Hyperion Brookfield Asset Management Inc., which took over as the fund's investment adviser in late July, said that firm hopes to turn the fund around by focusing on high-yield and investment-grade corporate bonds.

Some strong-performing funds now have a lot of their money riding on mortgage assets, as their managers hope to sort out some mortgage-backed investments that have been wrongly maligned from those that are truly bad. Giant $129.5 billion Pimco Total Return, up 4.3% in 2008, recently had more than 80% of its assets in mortgage-related securities, while TCW Total Return Bond , up 1.1%, recently had more than 90% of its assets in mortgage investments.

These funds' managers "found securities they feel are still solid credits," says Morningstar's Mr. Jones. "They've bought them at attractive prices, and they could help returns for years to come" if the bets pan out.

HIGH-YIELD AND BANK-LOAN FUNDS. There may be deals to be had in these hard-hit categories, but these funds are not for the faint of heart.

Junk bonds are yielding 14% on average, according to the Merrill Lynch High Yield 100 benchmark. But the pain in this sector is likely to get worse before it gets better. These below-investment-grade bonds represent the borrowings of the economy's least healthy companies -- the ones most likely to fail during a recession.

For now, the default rate among speculative-grade bond issuers world-wide, as tracked by Moody's Investors Service, is a pretty mild 3.1%. But Moody's expects that number to more than triple this year, to 10.4%.

Last year was so tough on junk-bond funds that even the category's best performers were all down at least 5%. Tom Price, co-manager of Wells Fargo Advantage Short-Term High Yield Bond, which fell 5.8%, thinks yields have gotten fat enough now to compensate investors for the risk of ballooning defaults, at least on higher-quality junk bonds rated single-B or double-B by ratings agencies.

"There is no question defaults are going to increase dramatically in '09, but it seems to be priced in," he says. He adds that the market could pick up when it gets "past the fear of deflation," or a decline in the general level of prices for goods and services. Deflation is another major worry because it means heavily indebted companies would have smaller values should they ever need to be sold to pay off their creditors.

Like junk-bond funds, bank-loan funds involve borrowings by companies with less-than-stellar credit prospects. However, in a default, loan holders get paid back sooner than bondholders. Another attraction to fund investors: Interest rates on the loans usually float with market rates.

Until recently, these advantages helped bank-loan funds win a reputation as relatively conservative holdings. That reputation may be tough to win back.

Big declines in the category reflect a glut in the type of loans bought by bank-loan funds after other established buyers such as insurance companies and hedge funds became skittish about credit. "You had massive supply, and you lost your demand base," says Christine McConnell, manager of Fidelity Floating Rate High Income Fund. She thinks these buyers will eventually return, but the "the big question" is whether bank loans are now cheap enough, given declining corporate profits.

Ms. McConnell's fund -- the best performer in the category -- was down 16% in 2008.

MUNICIPAL BONDS. Many investors think the municipal market could be one of the best places to find bargains in 2009. National intermediate-term municipal-bond funds returned negative 2.4% on average in 2008, according to Morningstar. But bullish investors suspect the cause was forced selling by some large institutions, rather than significant worries that states, cities and other municipal borrowers will fail to pay.

"That left individual investors on their own to support the entire municipal market," says Morgan Stanley bond strategist John Dillon, creating "a vacuum."

There are attractive deals, with municipal bonds recently yielding more than comparable-maturity Treasurys -- an unusual situation considering investors don't pay federal or, sometimes, state and local income tax on interest from munis.

The best performing national intermediate-term municipal-bond fund in 2008, according to Morningstar, was Baird Intermediate Municipal Bond, which returned 6%. Morningstar says top-performing muni funds like this one benefited from focusing on high-quality bonds with shorter maturities.

Another popular way for fund investors to buy municipal bonds is through closed-end funds. These funds trade throughout the day on exchanges like stocks or ETFs. Unlike holders of other mutual funds, closed-end investors aren't guaranteed the chance to sell at a price that matches the value of the fund's underlying holdings. Recently many muni closed-end funds have been trading at steep discounts to that "net asset value," meaning they could be attractive buys.

Some muni funds that are attractive for purchase now, according to Thomas J. Herzfeld Advisors Inc., a Miami investment adviser that specializes in closed-end funds, are BlackRock Insured Municipal Income Trust, Delaware Investments National Insured Municipal Income and Investment Grade Municipal Income Fund. Investors should note that closed-end funds typically use leverage, essentially borrowed money, which can boost returns to shareholders but also poses extra risks.

Muni investors should also keep in mind that while the risk of defaults by states or major municipalities is small, they could still face losses if bonds are downgraded by rating agencies, or if interest rates climb.

INFLATION-PROTECTED BOND FUNDS. Bond funds that primarily hold Treasury inflation-protected securities, or TIPS, went on a wild ride last year. With these bonds, the principal is adjusted in line with the consumer price index. Over the summer, when soaring food and energy prices drove inflation above 5%, TIPS prices soared, and yields grew razor thin.

More recently, with oil trading at less than one-third its mid-summer peak, investors have been talking not of inflation, but of its opposite -- deflation. Moreover, some investors are shunning the TIPS market because it's far smaller and less liquid than the market for conventional Treasurys.

As a result of this double whammy, TIPS have been hammered, with the average TIPS fund down 3.9% in 2008, according to Morningstar. The two best-performing funds, Vantagepoint Inflation Protected Securities and BlackRock Inflation Protected Bond, posted gains of 1.2% and 0.6%, respectively.

Still, some think plunging prices have made yields attractive relative to standard Treasurys. Currently, 10-year TIPS yield about 2.11% before the inflation adjustment -- just a hair below the 2.25% yield on 10-year Treasurys. The difference implies investors expect inflation to amount to just 0.14% annually over the next decade, a figure that strikes many people as unrealistically low. As a result, investors willing to buy and hold the bonds can get protection against rising prices for a song.

INTERNATIONAL BONDS. Morningstar's world bond category -- down an average 1.8% in 2008 -- is another grouping with a lot of mixed performance. Some funds were up by more than 10%, and others were down by more than 10%.

Meanwhile, funds in a separate emerging-markets bond category were down by a hefty 18% on average. That disappointed investors who had bought into the "decoupling" theory -- the view that stock and bond prices in developing countries could hold up even as a recession in the U.S. punished domestic investments. Instead, falling prices spread like wildfire across the globe.

"In the last couple months, it's been indiscriminate selling," says Michael Hasenstab, manager of Templeton Global Bond Fund. "If a country has good or bad debt, it's getting sold."

Templeton Global Bond fared better than most last year, finishing up 6.3%, in part because of its focus on government bonds rather than corporate bonds, which were even harder hit.

While 2008 was painful for investors, Mr. Hasenstab thinks the turmoil created bargains in places where debt was beaten down, such as Indonesia and Brazil, as well as opportunities to bet on interest-rate cuts by central banks in countries like Australia, New Zealand and Mexico.

"We're buying sovereign credits at distressed levels," he says. "Once the credit crisis ends, we expect them to return to fundamental levels," reflecting issuers' long-term financial health.

—Mr. Salisbury is a reporter for Dow Jones Newswires in Jersey City, N.J.


Noticias similares:
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  • Cobertura: más de 170 países y 250,000 bonos locales e internacionales.
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  • Herramientas analíticas: motor de búsqueda de bonos multi-parámetro, listado de seguimiento , mapas de mercado y otras herramientas