 |
|
To print article, click Print on your browser's File menu. Go back |
Related resources Research mutual funds Look up your favorite mutual fund family Find out what your mutual fund owns Here are the top performing funds Our 401(k) quick check can help you allocate your dollars |
|
Recent articles by Timothy Middleton: • A powerful, low-cost way to buy bonds, 1/20/2003 • How convertibles help one manager thrive, 1/20/2003 • Tax-savvy strategies for mutual fund investors, 1/20/2003 More... |
| The Basics | |||||||||||||||
| Why you should buy into the mortgage market | |||||||||||||||
|
If you really want to be in government-backed bonds, you can't beat Ginnie Mae funds. Yields are unusually lush right now. Opportunity also abounds in munis and foreign bond funds. By Timothy Middleton At least some of the record amount of cash flowing into bond mutual funds is going the right direction -- into mortgage-backed securities. We dont really like Treasurys now, says Mark Kiesel, a member of Pimco Funds investment committee. Were buying mortgages. Commonly called Ginnie Mae funds, shorthand for the Government National Mortgage Association, these are something we rarely see these days: government bond funds that dont appear overpriced. Another attractively priced group: municipals. And an even prettier bird on that roost: the sovereign debt of European countries.
The dollar's decline is a big factor in the international play. The biggest attraction, frankly, of international bonds today are the prospects for currency returns, says Arthur Steinmetz, co-manager of Oppenheimer International Bond Fund (OIBAX). U.S. Treasurys are overpriced The whole worlds favorite bonds right now are U.S. Treasurys. But those bonds are probably overpriced. Foreign investors, a huge fraction of Treasury owners, are retreating to their own economies. And interest rates dont have much room to move lower -- and lots of room to move higher. Related news and commentary on MSN Money
More value in the high-quality bond market can be found with mortgage debt. Most mortgage-backed securities are also backed by the government, but the risk they face is quite different from that of Treasurys. The latter are hurt when rates go up; the former can benefit. A decline in rates causes homeowners to refinance. When that happens mortgage-backed securities, such as those owned by Pimco Total Return Mortgage Fund (PMRAX) or the Vanguard GNMA Fund (VFIIX), are paid back earlier than investors would want. Whats more, investors get their money back at the worst time -- when alternative investments are yielding less. But with short-term interest rates at extremely low levels, the refinancing boom is nearing its end. Ginnie Maes are appealing now because mortgage rates have become somewhat sticky, Kiesel says. The biggest wave of refinancings is over, but mortgage-bond yields remain relatively lush. Youre getting paid a lot of money right now to own that mortgage, Kiesel says. As interest rates rise, Treasury bonds will suffer. So will Ginnie Maes, but less so, because prepayment risk is greatly reduced. Mutual funds that specialize in the bonds will also earn a gradually rising yield as fresh paper replaces older bonds in their portfolios. Want yield? Go foreign Foreign bonds, and particularly those of European governments, are likewise looking better and better. In the 1990s, foreigners flooded U.S. capital markets with money to participate in that decades great bull market in both stocks and bonds. To play, they had to pay in dollars, which drove up the greenback's value. Now, that story is turned around; foreigners at the margin have been taking their money home, Steinmetz says. That starts to push down the price of the dollar and push up the price of euros. The riskiest foreign bonds, those of emerging nations like Brazil, are also among the most attractive, Steinmetz believes. About 40% of our fund is in emerging markets, on a valuation basis, he says. Yields have gotten incredibly high. Those yields average about 11%, the manager says. Emerging markets bonds get no kick from currencies because they're denominated in dollars, but they are being kicked around by the marketplace, making them attractive to value-oriented investors like Oppenheimer. Munis offer least risk if rates rise Back at home, the bonds of local and state governments are somewhat more attractive than Treasurys, but only on a relative basis: Rising interest rates would whack them, too. If youre going to own something in the fixed-income market, you cannot avoid damage to market value if rates rise, says Reid Smith, co-manager of Vanguard Insured Long-term Tax-Exempt Fund (VILPX). The question is: Which bonds minimize the damage from rising rates?" His answer is municipals. Spreads are so high relative to Treasurys because tax-exempt bonds typically play catch-up, lagging Treasurys when theyre going up, but also when theyre going down. Right now, this historical pattern is exaggerated by rising credit risk among local governments, and a flood of fresh tax-exempt bonds as localities refinance to get lower interest rates. Smith believes the credit worries are overstated. No state in this country has gone bankrupt since Mississippi, and that was right after the Civil War, he says. So if you absolutely insist on owning straight government bonds, munis are better than Treasurys. Long-term munis now are yielding 5%, which in the 28% bracket is the taxable equivalent of 6.94%. Treasurys of similar maturity yield 5.16%. Living in high-tax New Jersey, I always keep my cash in a tax-free muni money market fund. But for longer periods, I think munis are riskier than I want to mess with. The odds that rates will rise significantly in the next three years is probably above 80%. Give me almost anything but pure government bonds. | |||||||||||||||
| |||||||||||||||
MSN Money's editorial goal is to provide a forum for personal finance and investment ideas. Our articles, columns, message board posts and other features should not be construed as investment advice, nor does their appearance imply an endorsement by Microsoft of any specific security or trading strategy. An investor's best course of action must be based on individual circumstances.