Not many months ago, it seemed that bonds were exactly the wrong thing to own. And even worse, our easy-to-own, packaged closed-end bond funds were getting pounded even as their underlying portfolios were hanging in there.
That was last summer, a time that seems, amid the continuing
winter chill, as remote as its pleasant weather.
Bonds are now the new focus for investors and traders. More
and more folks, turning away from stocks, are heading for quality. And this
means bonds, but not just any bonds- government and upper-tier corporate paper.
Want proof? Take a look at the graph below, which shows the
performance of intermediate-duration
The results are anything but fixed; we have gains and income
amounting to more than 12.5 percent for
It’s not just about racking up the regular interest payments.
Much of the gains have come since the start of 2008, with buyers lifting the
offers nearly everyday so far in 2008.
This has happened almost in defiance of conventional wisdom,
which says sell bonds when the US Federal Reserve Bank targets rates lower. The
chatter over headline inflation, fueled by energy and food prices, is all about
how high can it go and for how long. That’s not a typical setup for a bond
But what’s driving bonds isn’t the fear over how high
headline inflation will go, but rather how low the
Yet we can’t just buy any bond. Instead, we need to be picky.
We need to focus on bonds that aren’t just immune from credit-market woes, but are
also beyond the perception that credit risk will affect them.
Just as the markets have been shifting appreciation of risk,
we needed to focus our attention on which bonds will continue to perform and
which are really better off sold.
In the last issue, we sold a collection of individual bonds
that had either run their course or weren’t giving us enough return prospects in
light of mounting risks in the market.
Now we need to do the same for our collection of closed-end
bond funds in the Portfolio.
We’ve applied similar risk/reward measurements, resulting in
more calls to sell as we continue to refocus on funds that are performing well
now and have greater prospects for working without getting whacked for the next
The key is to look at the holdings and management of the
underlying portfolios so we understand how the assets have performed and how
the market perceives them going forward. Even if a fund’s portfolio is doing
well, we need to make sure the stock market won’t hit us just because the fund
is perceived as risky.
Last month, we sent the bulk of the floating-rate corporate
loan funds packing. It’s not enough now to expect the rest of the market to
take the time to go through portfolios; they keep selling or shorting them,
assuming the worst rather than assessing the reality of their investments.
And now we need to do some final pruning.
Income Strategies Portfolio (NYSE: DVF) isn’t as diversified as its title
suggests when it comes to evaluating what will work in the current environment.
Still loaded up with floating-rate bonds–which aren’t all bad but are
perceived to be of higher risk–the fund is running lower.
“Hit the highway” is what we’re telling management. Sell BlackRock Diversified Income
Income Fund (NYSE: KMM) has been a solid fund for years–until the past
several months. With a lower yield and some questionable strategies, the fund
doesn’t hold what we’d own on our own.
Although it’s down and trading at a discount, we need to
focus on what’s working now and is likely to continue working. Sell DWS Multi-Market Income Fund.
LMP Corporate Loan
Fund (NYSE: TLI) is one of the remaining floating-rate loan funds among our
collection. We kept it longer because of management’s positive steps to pick up
the best of this market segment.
However, with perception risk overwhelming the realities of
the credit markets, we can’t stick with it. Sell LMP Corporate Loan Fund.
Watch and Wait
Moving beyond the sells, we hold other funds that have the
right assets as well as the right management approach. But the market is sending
share prices down.
We’re putting a number of funds on watch while we dig deeper
into their prospects for not just better portfolio performance but better
recognition by the market of their potential.
Income Fund (NYSE: CFD) has a solid assortment of good-quality bonds that
pay well. But the market has either ignored it or seen it as something it’s
We don’t advise selling, nor do we advise buying more. 40/86 Strategic Income Fund is on watch; we’ll
update you in coming weeks on our final call.
DWS Global High Income
Fund (NYSE: LBF) is on watch because it’s been lagging the performance of
its component bonds. Trading at a hefty discount of more than 12 percent, the
lag in the stock versus the portfolio is concerning.
Our sense is that paying us well from quality bonds should
be enough to warrant renewing our buy call. But for now, DWS Global High Income Fund is on watch.
The same goes for Morgan
Stanley Emerging Markets Fund (NYSE: MSD). Armed with plenty of solid
government bonds, including many with improving credit and currency conditions,
the fund has lagged others. Morgan
Stanley Emerging Markets Fund is on watch pending our further poking around.
Rivus Bond Fund
(NYSE: BDF) holds assets that should also be working better for fund investors.
Rivus focuses on quality corporate bonds, which are behaving as they should,
but the fund is lagging.
Rivus Bond Fund is a
watch for now. We’ll see if it makes the cut in the weeks ahead.
Focus and Buy
The funds that remain are performing for us right now, just
as they have for years.
Global High Income Fund (NYSE: AWF) owns primarily government and
government agency bonds. It also holds select, high-quality corporates from
domestic and foreign issuers, which adds to our stability because we’re not
locked in to the
The average duration (measurement of price against changes
in yield) is a conservative-but-attractive 7.4 years. Its government issues are
top-grade and its corporates are of mid- to upper-tier credit quality.
The fund generates a yield just shy of 8 percent and returned
nearly 100 percent during the past five years. The return for the trailing year
exceeds 7 percent, and it’s up 2 percent in 2008.
Trading at a discount
of more than 6 percent to its meltdown value, AllianceBernstein Global High
Income Fund is a buy under 16.
Opportunity (NYSE: BNA) maintains its primary holdings in government and
government agency bonds, issued inside the
The fund has generated a return of nearly 39 percent for the
past five years; it’s in positive territory for the trailing year and for 2008
as well. Trading at a discount to its
assets of more than 8 percent and yielding more than 6 percent, BlackRock
Global Government (NYSE: RCS) is the gold standard of bond funds. More than
70 percent of its holdings full boast AAA/Aaa ratings, a fact that comes as no
surprise given its government focus. Because of its low average duration of
about four years, even if we get the direction of rates wrong we won’t get
The return numbers are more modest relative to other members
of our collection. But performance is more predictable. The return for the last
five years is in the upper-20 percent range. Year-to-date, however, it’s up
more than 10 percent. It’s the one to go to when the markets have issues. Paying a yield of 7.4 percent, PIMCO Strategic Global Government is a buy
Following Pimco are two government bond funds that focus
their holdings primarily outside the
Templeton Emerging Markets has returned more than 70 percent over the past five years. The
fund is up nearly 5 percent so far in 2008. It yields more than 7 percent and
is trading at a discount of 6.5 percent.
The average duration for portfolio holdings is comparable to
PIMCO Strategic Global Government’s, and the average credit is investment-grade-plus.
Government bonds comprise the majority of its holdings.
Western Assets Emerging Markets has similarly solid
credentials; average duration is shorter at around one year, and the average
maturity is just six years. The majority of its holdings are government bonds,
too. We have the stability we need.
Along with its prime corporate holdings, the portfolio mix
should ensure performance in line with its five-year return of about 56
percent. The fund yields a little less than 9 percent and trades at a discount
of more than 10 percent.
Emerging Markets Income Fund under 17 and Western Assets Emerging Markets under
In addition to our closed-end funds, we also hold one open-end
fund, Vanguard GNMA (VFIIX).
Vanguard GNMA focuses on the US-government-insured part of the mortgage market and,
as such, continues to prove nearly bulletproof.
It doesn’t pay as much as our closed-end funds, but it’s still an attractive cash alternative at more than 5 percent. The fund is still on track in 2008. Continue to buy Vanguard GNMA at current market prices.