(The opinions expressed here are those of the author, a
columnist for Reuters.)
By John Wasik
CHICAGO, June 30 Contemplating the end of a
30-year bull run in bond prices is a bit like waiting to go to
the dentist for some long-needed procedure. You know it needs to
happen, but you procrastinate.
The end of the bond rally has been telegraphed for more than
a year, so it needn't be painful if you prepare for it now.
Some of the conventional wisdom on avoiding all bonds except
for short-maturity issues may be flawed. There are alternatives
that can make sense while producing modest yield.
If you want to sacrifice yield now for protection later,
consider a floating-rate bond fund that invests in securities
with variable interest rates. Here are two funds to think about:
* The SPDR Barclays Capital Investment Grade Floating Rate
ETF, for example, has little risk of losing money when
rates rise. It gained nearly 1 percent last year as the Barclays
U.S. Aggregate Bond Total Return Index - a benchmark for the
lion's share of the U.S. bond market - lost 0.2 percent. It
charges 0.15 percent for annual management expenses.
The sacrifice part is the short-term return: the SPDR fund
is up only 0.14 percent for the 12 months through June 27,
compared with more than 4 percent for the Barclays Index.
* The iShares Core US Aggregate Bond ETF, which
tracks the Barclays index with moderate risk, is up 4.3 percent
for the 12 months through June 27. It charges 0.08 percent a
year in expenses. I hold it in my 401(k) as a proxy for the
American bond market.
This fund would give you more yield than the SPDR fund and
broader exposure to the wider U.S. bond market.
BE WARY OF THE YIELD CURVE
What about the traditional advice in a rising-rate
environment - in which most bond prices fall - to go to bonds
with short maturities?
Keep in mind that you face loss of yield and some volatility
if you switch from bonds with maturities from five to 10 years
to bonds that mature in under five years.
"The short end of the yield curve may not be a safe haven in
the years ahead," says Joel Dickson, a senior investment
strategist in the Vanguard Investment Strategy Group in Malvern,
There also may be some shocks in store in long-maturity
bonds as the Federal Reserve retreats from its bond-buying
stimulus program later this year.
Danger also lies in short rates rising rapidly, according to
John Blank, chief equity strategist for Zacks Investments in
Chicago. "Once they start rising, long-term interest rates can
shoot up from their place between a range from 2.5 percent to 3
percent to close to 4 percent - all in a few weeks. That is
enough to shock fixed income markets and change the dynamics of
global asset allocation dramatically," he wrote in a recent
WHAT NOT TO DO
One of the worst tactics is to look at returns from past
years in bond funds and expect them to continue or to think that
traditional bond funds are safe havens. Past returns provide no
protection against future interest-rate hikes.
Last year's hiccup in the bond market proved that even the
most well-known funds are prone to losses. The A shares of the
Pimco Total Return fund , one of the largest
bond funds in the world, lost 2.3 percent last year. It's up
about 4.5 percent for the 12 months through June 27.
Longer-term, though, the fund has handily beaten the U.S. bond
market's main benchmark over the past three-, five- 10- and
But can you expect the Pimco fund, managed by embattled
management legend Bill Gross, to live up to high expectations
based on past returns? Thousands of investors don't think so, as
the $229 billion fund has had some $50 billion in redemptions in
the past year. The fund charges 0.85 percent for annual expenses
in addition to a 3.75-percent sales charge.
Noting investor dissatisfaction two weeks ago at the
Morningstar conference in Chicago, Gross sardonically called
himself a "70-year-old Justin Bieber," referring to the troubled
pop star. Gross said the "new neutral" environment will depend
upon what happens when the Federal Reserve stops buying Treasury
bonds in November. "The bond market has feasted on Fed buying,"
At the very least, investors should fine-tune their
portfolio's exposure to bond-market risk. Every bond fund has a
"duration" measure that will tell you how much the fund will
decline if interest rates rise one percentage point. The Pimco
fund's duration, for example is around 5 percent.
Also keep a close eye on expense risk. It makes little sense
to pay a sales charge for a bond fund or tolerate high expenses.
That's why exchange-traded bond index funds are the best deals.
High expenses eat into total return, which is low to begin with.
You will have even more risk of losing money if you're trading
bonds and don't hold them to maturity or hold interest-rate
sensitive securities like real estate investment trusts or
(Follow us @ReutersMoney or here;
Editing by Beth Pinsker and Dan Grebler)