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posted: 6/30/2013 7:33 AM

Mid-year mutual fund review: Bond funds sink

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Associated Press

NEW YORK -- Brace yourself. If you have money in a bond mutual fund, you're likely to feel some pain when you open your mid-year account statement.

After years of steady returns, many bond mutual funds have suffered losses this year. Some of the sharpest drops are in funds that buy Treasury bonds, and it could be a rude awakening for investors lulled into thinking Treasurys were among the safest investments.

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A look at how other mutual-fund categories performed during the first half of 2013 shows other clear losers, as well as winners. Mid-year is often a time when investors check on their portfolios, but it's important to only make adjustments that are in line with your investment goals.

"While performance can give you a guide as to how a fund or ETF has done, it's not gospel," says Todd Rosenbluth, director of ETF and mutual fund research at S&P Capital IQ. "You should not chase performance. You should use it as one of the tools to help you sort through the investment universe."

Among the biggest losers of the first half of 2013: mutual funds that own long-term government bonds, like 30-year Treasurys. They lost an average of 10 percent through Wednesday, according to Morningstar. That follows returns for the category of 3.9 percent in 2012, 32.9 percent in 2011 and 11.7 percent in 2010.

Demand for bonds has declined because of concerns that the Federal Reserve may ease up on its bond-buying economic stimulus program. Chairman Ben Bernanke said that the central bank may slow its purchases later this year and halt them altogether by mid-2014.

The drop in demand has forced prices down for bonds. The price decline has been more than enough to wipe out the regular interest payments that bonds make. When a bond's price falls, its yield rises, and a 30-year Treasury bond yielded 3.57 percent on Wednesday. That's up from a low of 2.83 percent on May 1.

"You don't need a big move in bonds to eliminate a whole year's worth of income," says Mark Spellman, manager for the Value Line Income and Growth fund, which has a four-star rating from Morningstar.

Long-term bond funds are hurt even more by interest rate increases than short- or intermediate-term bond funds. That's because 30-year bonds are locked into the lower rates for longer periods, making them less attractive. Intermediate-term government bond mutual funds have lost 3.1 percent so far this year, and short-term government bond funds have lost 1.1 percent, fractions of the losses for long-term government bond funds.

A look at other winners and losers among mutual-fund categories in the first half of 2013:

Fund category winners

-- Health-care stock funds. The group returned 20.9 percent, more than any other category. Hospital stocks have risen on expectations that the health care overhaul will mean more patients have insurance coverage, leading to bigger profits. Biotechnology stocks, meanwhile, have surged on excitement about drugs in development.

-- Diversified U.S. stock funds. The U.S. economy looks to be in better shape than others in Europe and the developing world. Home prices are rising, the consumer confidence index hit its highest level in June since January 2008 and employers added an average of 189,000 jobs monthly through the year's first five months.

The Standard & Poor's 500 index of big U.S. stocks hit a record high on May 21, before giving up some of its gains on worries that the Federal Reserve will trim its stimulus. As an example, the average U.S. large-cap value mutual fund returned 14.4 percent, versus a 2.1 percent return for funds that invest in similar stocks outside the United States.

-- Japanese stock funds. Investors are hopeful that the latest attempt at stimulus by the Bank of Japan will jolt the world's third-largest economy. The stimulus has caused the value of the yen to fall 11.3 percent against the dollar so far this year. That helps Japanese exporters by making their cars and electronics more affordable to customers buying in other currencies.

Japanese stock mutual funds returned an average of 14.8 percent, although their gains have come down over the last month on concerns about whether the stimulus is aggressive enough.

Fund category losers

-- Emerging-market funds. Funds that invest in stocks or bonds from China, Indonesia and other developing economies have been hit hard by worries about a pullback by the Federal Reserve. For years, investors took advantage of the low interest rates promoted by the Fed's stimulus to borrow dollars and plow them into higher-yielding investments from emerging markets, says Alec Young, global equity strategist for S&P Capital IQ. But now that expectations for stimulus are waning, so is demand for emerging-market stocks and bonds.

Emerging-market funds have also been hurt by worries about slowing economic growth in China. Emerging-market stock mutual funds lost 10.2 percent in 2013 through Wednesday, while emerging-market bond funds fell 8.5 percent.

-- Precious-metals funds. The price of gold has tumbled through 2013, with losses accelerating in the second quarter. Gold on Wednesday hit its lowest settlement price since August 2010, and that has hurt mutual funds that hold the metal or shares of mining companies. Precious-metals funds lost an average of 49.9 percent.

Investors buy gold when they're worried about inflation, and some investors expected the Federal Reserve's stimulus to cause a spike in prices. But inflation has remained modest, which has dulled the appeal for gold.

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