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High-Quality Bond Funds -- First Quarter 2005 Review

By Staff Writer

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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)

+1.4

 Potomac Evolution Managed Bond/Investor (PEMVX)

-4.8
Calvert Social Investment Fund: Bond Portfolio/I (CBDIX)

+1.1

 Dreyfus Premier Corporate Bond/C (DCBCX)

-3.0
Strong Ultra Short Term Income Fund/Ist (SADIX)

+0.8

 PIF Preferred Securities/AS

-2.5
Evergreen Ultra Short Bond/I (EUBIX)

+0.7

 TA IDEX Transamerica Flexible Income/C (IFLLX)

-1.9
STI Classic Fds Super Short Income Plus/Institutional (SISSX)

+0.6

 Dreyfus Premier Core Bond Fund/C (DRCCX)

-1.9
Government Bond Funds
Best Performers

First Quarter 2005 Returns (%)

 Worst Performers

First Quarter 2005 Returns (%)
American Century Target Maturity 2030/Inv (ACTAX)

+6.6

 ProFunds: Rising Rates Opportunity/Sv (RRPSX)

-1.8
Potomac Contrabond Fund/Investor (PCBDX)

+3.9

 Reynolds Balanced Fund (RBALX)

-1.6
American Century Target Maturity 2025/Inv (BTTRX)

+3.8

 State Farm Interim Fund (SFITX)

-1.5
ProFunds:US Government Plus/Iv (GVPIX)

+2.1

 Rydex Srs Tr:Juno Fund/C (RYJCX)

-1.4
American Century Target Maturity 2020/Inv (BTTTX)

+1.9

 Flex-fund:US Government Bond Fund (FLXBX)

-1.4

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:[email protected].