In risk-averse time, bonds remain stabilizers

Shares in more than 93 percent of all stock funds fell during the second quarter, representing a loss to shareholders of an estimated $358 billion in paper value, according to fund-tracker Lipper Inc.

On the other hand, about 91 percent of all bond funds showed positive returns for the quarter.

But are bond funds still a good place for money?

There's a widespread expectation that the Federal Reserve will hike short-term interest rates before year's end.

If longer term interest rates also climb higher, then prices of outstanding bonds would normally fall.

Yet Kathleen Gaffney, a portfolio manager for Loomis Sayles Bond Fund, figures that bonds, at least corporate bonds, remain a good investment.

"Given the skittishness in the market, it would be difficult for the Fed to move rates up soon," she says. "The next move is up. But we have time."

Pointing to the various company scandals, notes the co-manager of the $1.3 billion, Boston-based bond fund. "There are risks in regard to corporate America. But in these periods of uncertainty, you usually do well. You just have to be careful in picking your spots" – your bonds.

Mark Kiesel, a portfolio manager at PIMCO, in Newport Beach, Calif., says high levels of individual credit-card debt and corporate debt are coming home to roost. Both individuals and companies are de-leveraging, spending less, saving more.

"Cash is king," says Mr. Kiesel, who helps manage $240 billion in fixed-income investments. "Investors are throwing up their hands with the stock market. Bonds are better."

Lately, mutual-fund investors appear to agree. According to the Investment Company Institute, a mutual-fund trade group in Washington, flows into bond funds reached $10.6 billion in May. That compares with $4.83 billion of cash for stock funds.

Some investors, including retirees, may like the relatively steady income a bond fund can provide, even if the share price bounces around somewhat with shifting interest rates.

Using a mathematical technique that adjusts for risk, relatively stable corporate bonds outperformed volatile stocks from Jan. 1, 1990 to May 2002, according to a study for Moody's Investor Services. Without that adjustment, stocks offered a 1.2 percent average monthly return versus 0.7 percent for bonds.

"You should always have a mix of bonds and stocks, depending on your individual situation," says John Puchalla, a Moody's senior economist.

For risk-taking investors, an especially scary number has been the 71 percent decline in Nasdaq stocks, many of them in high-tech companies, since March 2000.

By contrast, the 4,428 bond funds tracked by Morningstar, a Chicago-based fund-tracker, were up 2.65 percent on average in the first half of this year. Not spectacular. But not negative either.

About 20 bond funds had a total return of 10 to nearly 20 percent so far this year, some of them investing in foreign bonds.

Loomis Sayles Bond Fund is up 4.5 percent so far this year.

The fund has not entirely escaped the nation's corporate turmoil, though. It held some WorldCom bonds. The loss on the bonds, now sold, cost perhaps a penny on the fund's share price of about $10.43, reckons Ms. Gaffney.

Since bonds funds generally hold a diverse portfolio of bonds, the failure of a single corporation is unlikely to cause a serious drop in share value.

Most funds "can stand an occasional hit," notes Scott Berry, an analyst with Morningstar.

Gaffney is counting on an improvement in corporate governance and the economy to help lift the uncertainty and gloom that pervades financial markets today.

In her view, corporate bonds offer more value than Treasuries. Investors, frightened by market uncertainties, have pushed up the price of government debt to where there is "little upside" left.

Her fund can put as much as 20 percent of its total investment in high-yield bonds, often called "junk" bonds.

Mr. Kiesel sees a problem with any risky investments. This year, he notes, $100 billion of investment-grade corporate bonds have been downgraded to junk status by bond rating agencies. Some are selling at, say, 76 cents on the dollar of face value. Some even less.

"We are sitting on one of the worst credit markets in 13 years," he says. There is insufficient demand for risky debt. Money is seeking a "safe haven right now."

And he expects stocks to fall further, to "realistic" levels.

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