April 4, 2005 -- After three years of enjoying sustained gains, high-quality corporate bond and government bond funds posted a weak first quarter, suffering under the weight of rising interest rates, a surge in long-term Treasury yields, and growing fears over inflation.
The average high-quality corporate bond fund declined 0.63% in the first quarter of 2005, while the average government bond fund dropped 0.40%. However, these performance figures outpaced broad domestic equity indices.
Corporate bonds funds with shorter durations tended to outperform their longer-duration counterparts, since shorter-duration funds are less sensitive to higher interest rates.
The top-performing high-quality corporate bond fund for the quarter, the Dreyfus Institutional Yield Advantage Fund/Inv (DYAIX), seeks to maintain a minimum average credit quality of "A" and an average effective duration of one year or less.
"In the higher-quality corporate bond space, the high-beta sectors -- like autos, telecoms and cable -- were particularly weak during the first quarter, and faced selling pressure from investment-grade managers," said Kathleen Gaffney, co-manager of the Loomis Sayles Bond Fund/Retail (LSBRX).
Key to the fortunes of bonds this year will be how much the Federal Reserve raises short-term interest rates going forward, having hiked the target to 2.75% at their meeting in late March, the seventh consecutive such move since June 2004. Since that meeting, the yield on the benchmark 10-year Treasury rose as high as 4.69%.
While the central bank has seemingly committed to boosting rates at a "measured pace," further signs of inflationary pressures could compel the Fed to tighten more aggressively, thereby putting more of a damper on fixed-income performance.
Gaffney said Loomis Sayles is forecasting a target of the federal-funds rate between 3.50% and 4.00% by the end of 2005; and yield to the 10-year Treasury of between 5.00% and 5.25%. "The Fed is clearly working to move rates up, but not too fast," she said.
Standard & Poor's Investment Policy Committee believes the federal-funds rate will likely finish the year at 4.00%, with the yield on the 10-year Note at 5.00%.
|High-Quality Corporate Bond Funds|
|Best Performers||First Quarter 2005 Returns (%)||Worst Performers||First Quarter 2005 Returns (%)|
|Dreyfus Institutional Yield Advantage Fund/Institutional (DIYAX)||
|Potomac Evolution Managed Bond/Investor (PEMVX)||
|Calvert Social Investment Fund: Bond Portfolio/I (CBDIX)||
|Dreyfus Premier Corporate Bond/C (DCBCX)||
|Strong Ultra Short Term Income Fund/Ist (SADIX)||
|PIF Preferred Securities/AS||
|Evergreen Ultra Short Bond/I (EUBIX)||
|TA IDEX Transamerica Flexible Income/C (IFLLX)||
|STI Classic Fds Super Short Income Plus/Institutional (SISSX)||
|Dreyfus Premier Core Bond Fund/C (DRCCX)||
|Government Bond Funds|
First Quarter 2005 Returns (%)
First Quarter 2005 Returns (%)
|American Century Target Maturity 2030/Inv (ACTAX)||
|ProFunds: Rising Rates Opportunity/Sv (RRPSX)||
|Potomac Contrabond Fund/Investor (PCBDX)||
|Reynolds Balanced Fund (RBALX)||
|American Century Target Maturity 2025/Inv (BTTRX)||
|State Farm Interim Fund (SFITX)||
|ProFunds:US Government Plus/Iv (GVPIX)||
|Rydex Srs Tr:Juno Fund/C (RYJCX)||
|American Century Target Maturity 2020/Inv (BTTTX)||
|Flex-fund:US Government Bond Fund (FLXBX)||
Source: Standard & Poor's. Total returns are in U.S. dollars and include reinvested dividends. Preliminary data as of 3/31/05.
Contact Bob Keane with questions or comments at:firstname.lastname@example.org.