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Bond Funds Rise as Fear of Inflation Abates

February 06, 1988|Bill Sing

Bond mutual funds, in the dumps much of last year, are making a mini-comeback.

The bond market rally of the past three weeks, caused by expectations of a weaker economy and lower inflation, has sparked jumps in sales of funds investing in municipal, corporate, Treasury and even high-yield "junk" bonds.

Sales still are far from the boom levels of 1986 and early 1987, before a devasting slump started last April, when bond funds declined sharply in value as bond prices fell and interest rates rose.

But the recent rally is encouraging to an industry reeling from the October stock market crash, which depressed sales of equity funds as shellshocked investors sought haven in relatively safe money market funds.

"Bond funds are just about the only area where there is any activity," said Reg Green, editor of Mutual Fund News Service in San Francisco.

"Everything's turned very sharply up," said Brian Mattes, spokesman for the Vanguard Group of funds in Valley Forge, Pa. He noted that while January sales were strong across the board in bond funds, they were surprisingly strongest in high-yield junk bonds. "Investors were going after anything with a yield to it," he said.

Whether the rise in bond funds can be sustained depends largely on whether the bond market rally can continue and interest rates can continue to fall or at least stabilize. When interest rates fell or remained stable during much of 1986 and early 1987, bond fund sales skyrocketed, outselling equity funds by as much as 4 to 1.

But the April-May crash shocked thousands of investors who purchased bond funds thinking they provided stable returns. They were not prepared for the sharp declines in the values of their funds in the April-May period, when some funds plummeted in net asset value per share by as much as 15%.

By September, bond funds' net sales--total sales of new shares minus redemptions--had actually turned negative, meaning more money was leaving than coming in. In December, net sales were a negative $463 million, a sharp contrast to January, 1987, when net sales were a positive $13.5 billion.

But indications are that the recent negative numbers reversed this January. While no industrywide sales figures are available yet, a number of fund companies are encouraged that at least the worst is over.

"People are feeling better than they were in November," said A. Michael Lipper, president of Lipper Analytical Services, a Summit, N.J., firm that tracks fund performance.

"Since the beginning of the year, we've seen very strong interest in bond funds," said Justin O'Neill, spokesman for Fidelity Investments in Boston. "But one month does not make a long-term trend," he said, adding that Fidelity doesn't expect total sales in 1988 to recover to the boom levels of early 1987.

Clearly, investors are encouraged by recent results of bond funds, which have risen 3.16% this year through Thursday, according to Lipper Analytical Services. That includes gains from yields as well as capital gains from rising bond prices. By contrast, general equity funds were up 1.93% in the period.

Three of the 10 best-performing mutual funds so far this year are bond funds, according to Lipper. They are Benham Target 2015, ranked first with a 16.23% gain; Benham Target 2010, fourth with a 12.63% rise, and First Investors U.S. Government Plus-I, seventh with an 11.3% rise. All three invest in zero-coupon Treasury bonds, which tend to rise the most in value when interest rates fall.

The reason for the comeback: new statistics that have increased optimism for stable or lower interest rates. The economy is more sluggish than previously thought, these figures show, and that has reduced expectations of inflation.

Bonds also have been aided by the recent rebound in the dollar, which has reduced fears among foreign investors of declines in dollar-denominated bonds. That could help U.S. bonds outperform foreign bonds, reversing the situation of last year.

Investors also may be taking hope from the fact that 1988 is an election year. The Federal Reserve will be under extreme political pressure from the Reagan Administration to keep interest rates from rising and throwing the economy into a recession, investors reason.

Investors also are still scared of stocks, with the memories of the 508-point plunge in the Dow Jones industrial average on Oct. 19 still fresh in their minds.

Still, caution is in order when treading into bond funds, particularly those that invest in bonds with longer maturities. While they post the strongest gains when interest rates fall, they also suffer the largest declines if interest rates rise.

Some advisers fear that the recent bond market rally may be slowing and that interest rates may blip upward soon. Consequently, they recommend bond funds with shorter maturities. These will yield a bit more than money market funds yet won't have the price volatility of longer-term bond funds.

Joe Mansueto, president of Morningstar Inc., a Chicago firm that tracks fund performance, recommends several shorter-term bond funds without "loads," or sales charges. They include Fidelity Intermediate Bond Fund (800-544-6666, up 3.82% in the year through Jan. 29), Vanguard Fixed Income Series-Short Term Portfolio (800-662-7447, up 6.54%) and Neuberger & Berman Limited Maturity Bond Fund (800-367-0770, up 4.53%).

Others, however, are bullish on the bond market and thus recommend longer maturities.

Robert L. Rodriguez, chief investment officer for FPA New Income Fund in Los Angeles, one of last year's top-performing bond funds with a 7.6% gain, expects further declines in interest rates as the U.S. trade and budget deficits improve in the coming months. The average maturity of securities in his fund are just under 10 years, about twice the industry average for bond funds.

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