Mutual Funds

The Five Best Bond Funds

These are good funds to own when interest rates rise.

By Steven Goldberg, Contributing Columnist

From Kiplinger's Personal Finance magazine, May 3, 2004

It's hardly a secret: Interest rates are almost surely heading up. This puts bond-fund investors in a bind because higher rates mean lower prices. The best strategy: own funds with relatively short maturities because they should hold up better in a rising-rate environment.

The anchor of your fixed-income portfolio should be Harbor Bond. This fund is managed by Pimco's redoubtable Bill Gross, who is known for his uncanny ability to forecast the direction of interest rates. In each year since 1995, Harbor Bond has finished in the top 40% of its category -- funds that invest in high-quality, intermediate-maturity bonds. Its 7% annualized return over the past decade is one and a half percentage points ahead of the category average. Recently, the fund's average maturity was nearly seven years, and it sported a yield of 2.5%. Be aware that the New Jersey attorney general recently accused Pimco of permitting rapid trades in several of its funds (but not Harbor Bond, for which Pimco is the sub-adviser).

A more aggressive choice is Loomis Sayles Bond. Dan Fuss, who launched the fund in 1991, has been in the bond business since 1958. Now 70, he hasn't let age slow him down. Fuss and co-manager Kathleen Gaffney, 42, invest in all kinds of bonds, most of them high-quality, from all over the world. Loomis Sayles Bond has run rings around other similar funds (those that invest in different types of bonds from all over the globe), landing in the top 40% of the group in seven of the past ten years. Over that period, the fund returned an annualized 10%, four percentage points per year ahead of the average. Recently, the fund had 36% of its assets in short-term foreign bonds, which should perform well if the dollar keeps weakening. The fund yields 5.9%.

You may wonder how we can call a fund that's less than four years old a gem, but Fidelity Floating Rate High Income is certainly one of the best to buy now. Few bond funds will protect you better from rising rates. Floating Rate invests primarily in senior bank loans. Interest rates on those loans are typically reset every three months, meaning that both the fund's yield and its price should rise if short-term rates do. The fund mostly invests in loans that are made to weaker companies, but manager Christine McConnell, 46, says that her analysts painstakingly research the loans to avoid ones that may go bad. The average maturity of Floating Rate's investments is less than four years, and the fund yields 3.2%. Over the past three years, it returned 4% annualized.

If you're investing in a taxable account and you're in a high tax bracket, you'll probably do better with a municipal-bond fund. Vanguard Intermediate-Term Tax-Exempt, for example, yields 2.7%. But because the interest it pays is exempt from federal income taxes, that's the equivalent of 3.8% from a taxable investment for someone in the 28% bracket. The average maturity of the fund's holdings was recently six years. Run by Christopher Ryon, the fund benefits from minuscule annual expenses of 0.17% and was in the top 20% of intermediate-term muni-bond funds over the past five years, with an annualized return of 5%.

Another fine choice is Fidelity Spartan Intermediate Municipal Income. Despite slightly higher annual fees (0.43%), the fund, which is managed by Doug McGinley, returned slightly more (0.4 percentage point per year) than its Vanguard counterpart over the past five years. The average maturity of its holdings is eight years, and the fund yields 2.7%.

--Reporter: Katy Marquardt

• Print
• Comments
• Email
• RSS