High-Quality Bond Funds -- Mid-Year 2003 Review

July 3, 2003 — The average high-quality bond fund returned 4.1% during the first half of 2003. While almost all funds in the category finished the second quarter in positive territory, some were able to beat the average as of mid year by a considerable margin.

So far, corporates have been outperforming relative to other investment-grade bond sectors. For Ryan Brist, manager of Delaware Group:Extended Duration Bond Fd/I (DEEIX) and Delaware Group:Corporate Bond Fund/A (DGCAX), an overweight in lower quality areas of the investment-grade corporate bond market, especially sectors such as telecom and electric utilities, helped both his funds outperform. Texas Utilities, Duke Capital, XEL Energy and Center Point Energy Resources have been “the key names where we have achieved dramatic gains in the portfolio,” he said. Both Delaware funds were on the top ten list for the period.

For Kathleen Gaffney, co-manager of Loomis Sayles Bond/Instl (LSBDX), performance in the first half was partly attributable to the fund’s non-dollar exposure, which makes up around 40% of the portfolio, representing the developed world. The emphasis on corporate bonds — 20% in BBB’s and 35% in high yield — was another factor. The portfolio was the second best performer in the first half, returning an outsized 18.7%.

According to Janet Rilling, portfolio manager of Strong Corporate Bond Fund/Instl (SCBNX), companies started addressing their balance sheets and liquidity concerns as of last October, especially those in the telecom sector. She says that since then, each month has shown positive outperformance for the BBB part of the investment grade market, which is where the fund is focused, versus Treasuries. Her portfolio returned 9.5% in the first half, putting it on the list of top ten performers. The fund invests between 10%-12% in foreign issues, primarily in Europe, and no more than 15% in high yield.

With interest rates now at forty-five year lows, and the market confident they will stay this way, there could be a lot of interest in the corporate bond sector going forward as a result of a fairly healthy appetite for yield. In general, over the next six to twelve months, a moderate growth in the economy is expected. For some portfolio managers, such as Gaffney, the greater risk is that inflation will come back at some point, probably resulting in future investments in Treasury Inflation Protected Securities, or TIPS.

– Daniela Valle

High-Quality Bond Funds