Businessweek Archives

It's Getting Late To Leap Into Bonds


Finance

IT'S GETTING LATE TO LEAP INTO BONDS

It's almost like a gold rush. Since the Federal Reserve began pushing down interest rates last August, the bond market has staged a dramatic rally. The scramble to buy in has helped send yields on long-term Treasury bonds to 7.88%, their lowest level in almost two years. Those who were already holding bonds can smile all the way to the bank. Those considering joining the rush, though, face the eternal bond-market conundrum: Do you stay short-term to wait out the rally? Or do you lock in the highest yield you can find? And with the myriad bond investments to choose from, where are the best rewards for the risk?

A lot of money is chasing the answers to those questions. Investors are leaving low-yielding money-market funds and certificates of deposit in droves. Since January, $36.7 billion has poured into bond funds, vs. $14.9 billion for the same period in 1990, according to the Investment Company Institute. That shift of assets may be just the beginning, since $1.2 trillion remains in CDs for amounts under $100,000. When a wave of CDs matures in October, more money will join the hunt.

Those counseling investors to stay short posit that the Fed's latest interest-rate cut will be its last and will jump-start the economy. That would subdue the rally and make a money-market or short-term bond fund a good bet. "People should be very cautious about buying long-term bonds right now," says Kurt Brouwer, president of Brouwer & Janachowski, a San Francisco-based investment adviser. "They made the mistake of being in CDs and money funds and not locking in yields, and now they're making the mistake of locking in yields at the bottom of the market."

Taking a few steps out onto the yield curve, however, can give a boost to a portfolio. Five- to seven-year Treasuries bring close to 7.25%, compared with 5% or 6% on money-market funds. But the rewards for making longer-term bets are slim because the yield curve flattens after five to seven years. "With 7-to-10-year Treasuries, you get virtually the same return as on a 30-year bond, with less risk," says Michael Metz, chief investment strategist for Oppenheimer & Co.

At the opposite end of the risk spectrum, junk bonds have been rising in price since January. Norman G. Fosback, president of the Institute for Econometric Research in Fort Lauderdale, Fla., finds the average 13% yield on such junk-bond funds tempting. "All people have seen are the scare headlines," he says, "but investors in junk bonds have done very well this year, and there are still opportunities for gains." Wholesale dumping of junk portfolios by insurance companies and other institutions, he says, has kept prices depressed.

It's not a universal view. "Junk funds are danger from this point forward," counters William H. Gross, managing director of Pacific Investment Management Co. in Newport Beach, Calif. Gross doesn't necessarily expect a rash of defaults but feels that after a nine-month run, "there's a limit to how long the run can continue." Gross does like a few individual issues. His favorite: Occidental Petroleum Corp.'s 8.95% note, due Apr. 15, 1994. "It's rated BAA, but they've been paying off a lot of debt and selling companies right and left, so I'd put it near an `A' in quality," he says.

CITY DANGERS. Another bond area drawing a lot of money is municipals. Again, intermediate-term bonds get the nod from analysts, thanks mainly to the high volatility of long-term bonds. "You get most of the yield of a long-term bond, at only about 60% of the risk," says Ian A. MacKinnon, head of fixed-income securities at Vanguard Group.

But if you're moving into munis, don't sacrifice quality for yield. "The next fiscal year will be as difficult or more difficult than last year," says George D. Friedlander, managing director at Smith Barney, Harris Upham & Co. While he doesn't expect widespread defaults, he sees "state and local budgetary problems, and some downgrades."

Ginnie Mae bond funds, which invest in pools of mortgages backed by the Government National Mortgage Assn., have also seen tremendous inflows. Gross says that the funds, which yield 8.5%, are "the safest way to pick up yield." But if mortgage rates fall, homeowners will prepay mortgages, lowering the projected yield. "While that is a definite risk, for the individual it's probably the lesser of many evils," says Gross. He adds a comment that applies to the overall dilemma of playing today's bond market: "You have to take risks somewhere, or suffer the slings and arrows of a 5% money-market fund."Suzanne Woolley in New York


We Almost Lost the Nasdaq
LIMITED-TIME OFFER SUBSCRIBE NOW

(enter your email)
(enter up to 5 email addresses, separated by commas)

Max 250 characters

 
blog comments powered by Disqus