If you’re still not convinced that too many people are buying bonds, consider this: “More money flowed into domestic bond mutual funds in 2009 alone than in the previous ten years combined,” according to Paul Jacobs, a fee only planner at Palisades Hudson Financial Group’s Atlanta office.
It’s worth reminding clients that holding a bond to maturity guarantees a return, which is not the case with tulips or tech stocks. Bond funds, on the other hand, don’t mature.
“A sharp hike in rates could send long-term bonds down 20 percent or more,” Jacobs said.
For bond fund-buyers with a stomach for risk seeking higher yield, the choices includes actively managed funds with broad discretion and floating rate funds.
In a period when many people anticipate a general down-turn in the indices, it makes more sense than usual to choose an actively managed fund where managers can find the bright spots. Louis Stanasolovich, president of Legend Financial Advisors, recommends seven funds, ranked by the managers’ degree of discretion: Eaton Vance Absolute Return, Loomis Sayles Bond; Pimco Total Return; Hussman Strategic Total Return; Templeton Global Bond; Franklin Templeton Adjustable Rate Mortgage and Eaton Vance Bank Loan.
One of the latest entries is the newly-launched Loomis Sayles Absolute Strategies fund, which combines government, sovereign and corporate bonds along with commercial mortgage backed securities and residential mortgage backed securities. Instead of trying to beat a benchmark, the fund sets return goals of 6% to 7%, or 2% to 4% basis points over the London Interbank Offered Rate (Libor), whichever is greater.
Commercial mortgage-backed securities and residential mortgage-backed securities were abandoned along with the more risky collateralized-debt obligations, so may now be a buy, says Matthew Eagan, a co-manager of Loomis Sayles’ Multisector Bond fund.
Another idea is to add yield with a floating-rate fund. These invest primarily in debt securities that don't have fixed interest payouts, generally bank loans made to, or bonds issued by, companies with low-credit quality—usually not higher than BB.
The higher yields go along with higher risk, so Jacobs has his clients limit them to 10 percent to 15 percent of a portfolio. Jacobs favors the Fidelity Floating Rate High Income Fund because he believes it is the most conservative floating-rate fund. Annual expenses are 0.74 percent, almost half a percent lower than the average floating-rate fund.
Safety-lovers might stick with high-quality short-term bond funds, with durations of about one year. The Goldman Sachs Enhanced Income Fund, for example, invests in a mixture of corporate and US agency bonds, and has a low expense ratio, which is especially important in an era of low rates. Vanguard Short-Term Tax-Exempt Fund also boasts a penny-pinching 0.20 percent management fee. In the 2008 bond dip, both of these funds came through fine, says Jacobs.
Unlike most other bonds, US Treasury Inflation-Protected Securities (TIPS) appreciate in value when inflation goes up. Since all TIPs are the same, there’s no reason to pay a mutual fund company to manage them for you.
Among munis, despite the money flight, Pimco's Bill Gross says at 6.65% for New York City Build America Bonds at 6.65% and California’s 7% bonds are good choices. And despite the alarm in the muni market, actual defaults are still rare.