NEW YORK – The departure of Alan Greenspan and arrival of Ben Bernanke at the Federal Reserve have done nothing to deflect mutual fund investors from the Big Question: When will the Fed stop raising rates?
The question has stock investors nervous, especially after last week’s big drop in equities. But some bond fund investors might have their hands around a bottle of champagne.
Some analysts think both camps are wasting their time.
“Does it matter? No,” said Margo Cook, who oversees $6 billion of assets as head of institutional fixed income for Bank of New York’s BNY Asset Management. “Right now, investors should be thinking about diversified asset allocation.”
Cook and other industry experts believe mutual fund investors should consider bond funds as a ballast for a stock-heavy portfolio regardless of when the Fed ends its cycle of rate increases.
Nobody is suggesting investors take flight into bond funds because Wall Street, uneasy after 14 rate increases since 2004, is on the verge of a bear market. They still think stocks have plenty of momentum. What analysts recommend is that stock investors simply take a broader look at their portfolios because the bond market seems to be a relatively good bet right now.
Many analysts specifically point to bond funds that focus on short to intermediate maturities – or between two and 10 years. There’s some history behind their advice.
The past few decades have seen long-term bond funds providing investors the highest rate of return, especially during periods in which interest rates have been on the decline. But, these investments – which in some cases mature at 30 years – carry more volatility as long-term bond funds are extremely sensitive to interest rate fluctuations.
Short-term and intermediate-term bonds might be exactly what the financial planner ordered. Short-term bonds mature in less than two years, while intermediates expire in about 10 years. Historically, these funds are the ones to watch in the immediate aftermath of the Fed’s decision to stop raising rates.
Between 1994 and early 1995, the Fed raised rates seven times to 6 percent from 3 percent. Intermediate-term bonds then spiked to 17.8 percent. In 1999 and 2000, the Fed sent rates up six times to 6.5 percent from 4.75 percent – and, once finished, intermediate-term bonds logged a 9.7 percent return, according to data provided by Morningstar.
Some analysts predict double-digit returns in the coming year for funds that track intermediate-term bonds. Already this year, investors have sent intermediate-term bonds up 1.8 percent in anticipation these investments will follow history. Intermediate-term bonds also delivered a 5.3 percent annualized return over the past five years.
“I think it’s reasonable to start looking at bond funds,” said Todd Barre, vice president and senior investment strategist for Harris Private Bank. “If an investor is quite aggressively in equities right now, I think it is reasonable to diversify given the fact short funds give a nice yield.”
Some of the strongest bond funds this year include American Funds Bond Fund of America, Columbia Income, Summit Bond Fund and Pimco Total Return Institutional. All have returned 3-year annualized returns over 5 percent.
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