As Good As It Gets – bond fund returns unlikely to improve further – Brief Article

As Good As It Gets – bond fund returns unlikely to improve further – Brief Article – Statistical Data Included

Jeffrey R. Kosnett

FIXED INCOME | Those impressive one-year returns for bond funds are UNLIKELY TO PERSIST.

THE 12-MONTH results below might fool you into thinking that bonds have morphed into growth investments. They look impressive in comparison with the average stock fund’s returns, which have been underwater for the past year. But if you think that by investing in bond funds you’ll nail those increasingly elusive double-digit gains, you’ll almost surely be disappointed.

Bond mathematics is the culprit. Bond prices move inversely with interest rates, and when rates fall to today’s low levels, it strains credulity to expect yields to plunge still further. For example, the ten-year Treasury note, a widely watched benchmark, began 2000 yielding nearly 7%. Its yield eventually fell below 5%, making the note worth 15% more. To add another 15% in market value, the yield on the ten-year Treasury would have to sink to 3.1%.

A yield that low would suggest a sharp recession, which is unlikely. “The Treasury at 3.5% is a statement that the world is in a lot of hurt,” says Harry Resis, a bond manager with the Kemper funds.

Many strategists say Treasury yields have probably bottomed in the 5% range. This suggests that government-bond funds are likely to return only their yields over the coming year. High-quality corporate IOUs yield a couple of percentage points more than Treasuries, so they might do a hair better–but are unlikely to generate double-digit total returns.

High-yield funds offer the best opportunities. The average junk bond yields about eight percentage points more than the ten-year Treasury. Assuming that the economy doesn’t slip into recession and investors come to accept that the high-technology and telecommunications sectors (which are major issuers of low-grade debt) aren’t about to fall off the planet, junk bonds should at least return their yields.

COPYRIGHT 2001 The Kiplinger Washington Editors, Inc.

COPYRIGHT 2001 Gale Group