Nov. 7, 2003 — Market pundits have been warning for nearly a year that the bond market boom may be ending, but it took the summer’s sell-off for investors to pay attention. In mid-August, after the yield on the bellwether 10-year Treasury bond rocketed from a 45-year low of 3.07% to 4.67%, triggering double-digit losses at the worst hit bond funds, investors began hunting for a safe haven from rising rates.
“There’s a risk that a stronger economy in the new year will lead to higher interest rates,” says Marilyn Capelli Dimitroff, president of Capelli Financial Services Inc., a financial advisor in Bloomfield Hills, Michigan. Even fears of a Fed rate hike might send Treasury yields higher, and bond prices into a slump, she warns.
Some investors are reacting to the summer’s bloodbath by dumping bonds in favor of stock funds. But money managers and strategists note that there are a growing list of alternatives to this drastic and possibly ill-conceived response.
“If I think a 30% allocation to bonds is appropriate, I don’t want to take my clients out of the asset class, or even take them much below that level,” says Ms. Dimitroff.
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The traditional solution, and the one Dimitroff has used with many of her clients, is to move assets into short-term bond funds. With an average duration of three to four years, any losses caused by rising interest rates — whether due to rate hikes by Federal Reserve policymakers or to Treasury market gyrations — will be short lived, strategists note. Many of these funds hold half or more of their assets in higher-yielding short-term corporate bonds, such as Scudder Short Term Bond Fund/S (SCSTX), recently upgraded by Standard & Poor’s to a four-star ranking. Calvert Short Duration Income/A (CSDAX) holds 70% of its assets in corporate securities, and 11% in municipal bonds, while Columbia Short Term Bond Fund/B (CTBBX) keeps half in corporate securities and 25% in Treasuries. Advisors also need to monitor the duration of the funds’ holdings, which can range from as little as 1 year to 3 years, and which can fluctuate.
In recent months, mutual funds have begun rolling out ultra-short funds. With durations between 12 and 24 months, the category resembles a more volatile and higher-yielding money market fund, analysts say. One of the veterans of this new crop of offerings is Fidelity Ultra-Short Bond (FUSFX), launched a year ago. The Fidelity fund maintains about two-thirds of its assets in corporate securities. Investment Management Inc. introduced Dryden Ultra Short Bond Fund (PDUAX) last April, and by Labor Day the fund had pulled in some $400 million in assets. A more recent launch was the July debut of Evergreen Ultra Short Bond Fund.
“We certainly looked at (creating an ultra-short fund) because intuitively it made sense,” says Edward Wiese, senior portfolio manager at T. Rowe Price, “We decided against it, because our studies showed that you give up more return than you give up in volatility when moving from a standard short-term fund.”