The market’s debris is falling squarely on the shoulders of the pros who manage bond funds. More than 25 million Americans have money in them, and in recent years they’ve done well-the average U.S. Treasury fund gained 10.8 percent last year. But since February’s sell-off began, they’ve fallen more than 3 percent.
Here’s how bond-fund investors are hurt when interest rates rise: say your fund is holding an IBM bond that pays 6 percent a year in interest, and rates increase. Newer bonds will give a bigger yearly payment (called a coupon). If the manager wants to sell the IBM bond, she’ll find it’s lost value since buyers won’t pay as much for the smaller coupon. Traders call this interest-rate risk, and it’s why they’re losing sleep these days.
With prices plummeting, nervous investors have pulled $2.3 billion out of bond funds in the last five weeks, according to AMG Data Services. But many investors are choosing to sit tight, trusting their portfolio managers to keep them afloat. Here’s what managers are doing to fight back against rising rates:
How far a bond’s price drops is determined primarily by its maturity-the length of time until the principal is repaid to investors. By moving money into shorter-term issues, a manager makes his portfolio less sensitive to interest rates. “Of the tools a portfolio manager has, none is more powerful than reducing the average maturity,” says Ian MacKinnon of Vanguard. Managers there have lowered risk by reducing the maturity of their funds by an average of 15 percent since last year.
Many managers are holding on to cash to avoid the bond market’s gyrations, much like stock-fund managers are doing. At Fidelity, they’ve raised cash to pay off investors who head for the exit. In doing so, they’ve lowered their risk.
Some funds keep the reins tight on a manager, letting him buy only certain bonds of a specific maturity. But funds that give managers more latitude can pay off when rates spike. Ron Speaker, who runs Janus’s Flexible Income Fund, holds a chunk of high-yielding junk bonds, which provide higher returns and aren’t as susceptible to interest-rate risk. The result: his fund has lost only 1.2 percent this year, less than. the average corporate fund. Dreyfus bond manager Barbara Kenworthy has raised cash, moved money to short-term bonds and bought a complex type of security that is derived from mortgages and performs well when rates rise.
“Many of the strategies we can use are quite different than moms and pops can do on their own,” she says. That, after all, is how the pros earn their pay.
