Fund Watch
Lower Your Expectations for Bonds
The manager of Dodge & Cox Income says last year's stellar returns are unlikely to recur.
By Andrew Tanzer, Senior Associate Editor, Kiplinger's Personal Finance
April 13, 2010
One peculiarity of the past year’s stock-market rally is that individual investors keep pouring money into bond funds, dwarfing their contributions to stock funds. Tom Dugan, co-manager of Dodge & Cox Income fund (symbol DODIX), finds this pattern bemusing.
In 2009, Dodge & Cox Income, a member of the Kiplinger 25 list of top mutual funds, returned an impressive 16%. But “the kind of returns we had in 2009 are extremely unlikely to recur,” Dugan cautions. “You shouldn’t come into the bond market with the idea that 16% is achievable.” This refreshingly candid manager notes that the unusual economic and bond-market landscape that pertained in early 2009 “bears no resemblance to the current environment.”
For one thing, interest rates seemingly have nowhere to go but up. Dugan notes that at the end of 2009 (for which the fund most recently disclosed its portfolio), Dodge & Cox had allocated only 4% to Treasury bonds, a massive 27 percentage points below the overall bond-market index’s allocation (Treasuries had been as much as 30% of the fund’s assets in recent years). “We’re avoiding Treasuries more than ever before,” he says.
Instead, he says, he and his nine co-managers are finding better value in corporate bonds (ranging from HCA, the nation’s largest for-profit hospital company, rated triple-C, to double-A-rated GE) and in government-agency mortgage-backed securities. And to defend against the inevitable rise in rates, the fund is keeping its weighted-average duration (a measure of interest-rate sensitivity) much lower than that of the overall bond index.
Here’s another indication of Dodge & Cox’s views. This outstanding San Francisco fund family manages five quality funds, among them Dodge & Cox Balanced. Dugan, who is also a co-manager of Balanced, notes that 72% of the fund was allocated to stocks at last report (the end of December), with the rest in bonds and cash, compared with a benchmark weighting of 60% stocks and 40% bonds.
Dugan of course can’t tell you or anyone else precisely what returns to expect next from bonds. But he’s clearly advising that you dampen expectations for total returns. He notes that over long spans, the average weighted yield to maturity of bonds in a portfolio has been a good predictor of the total long-term returns. At the end of 2009, the Income fund’s portfolio had a yield to maturity of 4.2%. That’s a fair target, though in a normal year, this fund is capable of doing better. But “you’re promising alchemy if you promise something much higher,” he says.
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Reader Comments (2)
Posted by: Ave Joe at 04/13/2010 03:57:28 PM
Don't expect last yrs rtns? Like 5.9% for a Index-VBMFX fund? or 5.4% for GNMA-VFIIX? I don't see why not expect the same from them, do you? Maybe all the other bond funds that were not Indexed related and their fund Mgrs did some Sneaky tricks of Going Long or leveraging them should be suspect... And As for Corporate Bonds like VWEHX? It only did 1% in 02' and then 17% in 03', another recovery yr, so why not expect the sa,e % ratio of 17-1 when it lost -21% in 08; for 09'? and sure enough, it did about 40%...and this is why Bill Gross is saying it's back to the New/Old Normal.. .Now if we can just get Treasuries back to "Normal" and that is doing what they have done the past 10 yrs apy = 7.5% apy for VUSTX and 6.8% for Intermediate- VFITX.. Then we Seniors can Sell our Other Bonds and Equities and go buy them.. That is Unless Mr. Berneke wants to Stack the Deck against Treasuries and keep those rates way too low, like his predessor, Mr. Greenspan did.. after being told to by his, then Boss.. And how about this new "Bond Funds cannot use their own Rankings of their bonds" and will have to use Outside bond raters? Gee, I would think that was already on the books they should be doing.. or is it Putting the Fox in charge of the Hen House again..
Posted by: Ave Joe at 04/14/2010 11:04:48 PM
You're Right.. Anyone Foolish enough to think bonds will do 13% again is a fool.. Just Eliminate 09's returns and take the previous 10 yrs apy's instead..