3 bond funds prove their resiliency

These three bond funds employ strategies designed to excel in difficult market conditions.

By TheStreet Staff Dec 21, 2010 4:13PM

By Stan Luxenberg, TheStreet

 

During the past month, the average intermediate-term bond fund lost 1.1%, according to Morningstar. Now many economists worry that bond markets could face more hard times in 2011. Which bond funds will do best in the coming year?

 

To find promising choices, consider funds that proved resilient during the hostile bond markets of recent weeks. Among the top performers of the past month, my favorites include Pimco Floating Income (PFIAX), Templeton Global Bond (TPINX) and DoubleLine Total Return Bond (DBLTX). These resilient funds employ strategies that are designed to excel in difficult market conditions.

 

Bond funds have suffered lately as interest rates have risen. Yields on 10-year Treasuries have climbed to 3.33% from 2.6% in early November. Many forecasters predict that rates will continue rising in the next year. When rates climb, bond prices tend to drop as investors flee existing issues in search of new bonds with higher yields.

 

Among the steadiest performers during periods of rising rates has been Pimco Floating Income, which returned 0.7% in the past month, outdoing 91% of its multi-sector bond competitors. The strong showing was no fluke. When rates rose in 2006, Pimco outdid 99% of its competitors.

The fund excels in hard times by buying securities with adjustable rates. The yields on these rise when interest rates climb. As a result, the securities can hold their value during periods when most other bonds are falling.

 

Make no mistake, the Pimco fund comes with some risks. When rates fall, the yields on adjustable securities drop, and the fund can lag competitors; that happened in 2008.

 

The fund also courts risk by holding sizable stakes in bonds that are rated below investment grade. But the low-quality bonds should thrive this year if the economy grows, as most economists expect. During periods when gross domestic product is increasing, corporate defaults decline. That encourages investors to buy riskier bonds and bid up their prices.

Another resilient choice is Templeton Global Bond which returned 0.6% in the past month, outdoing 97% of its peers in the world bond category. Portfolio manager Michael Hasenstab ranges widely, placing big bets on Latin America one year and emphasizing Japan the next. When he becomes fearful, Hasentab can sell short, betting that bonds will drop. Most often his calls have been on the mark. The fund has returned 12.1% annually during the past decade, outdoing 99% of competitors.

 

These days the fund has little exposure to Japan and the eurozone where the yields are puny and the currencies could decline against the dollar. Instead, Hasenstab has big stakes in Norway and Australia. Because the economies of those countries are in healthy shape, the currencies should appreciate against the dollar, which would boost returns for U.S. investors.

 

A fund that can thrive in up and down markets is DoubleLine Total Return Bond, which lost 0.3% in the past month, outdoing 96% of intermediate-term bond funds. Portfolio manager Jeffrey Gundlach achieved top returns while running TCW Total Return (TGLMX). Then after quarreling with his management, he started the DoubleLine fund in April.

 

Gundlach specializes in mortgage-backed securities, which have peculiar advantages during periods of rising rates. The securities represent stakes in pools of home mortgages. When homeowners make interest payments on mortgages, the cash goes to the investors who hold the securities. Because of extra risks, mortgages yield more than Treasuries. The richer yield helps mortgages outdo Treasuries during periods of rising rates.

 

To boost results these days, Gundlach has been buying riskier mortgage securities that aren't backed by agencies. Some of his holdings sell at big discounts because of default risk. Gundlach says that since the securities were already selling at rock-bottom levels, they suffered only limited losses in the past month. If rates rise next year, the bargain securities should help to protect fund shareholders from market turbulence.

 

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