Not all bond funds are 'safe'
NEW YORK -- Investors rushing from a tumultuous stock market into bonds might find they run smack into the same problems if they don't look where they're going.
The stock market's recent upheaval over concerns about faltering mortgages among borrowers with weak credit -- and tighter overall access to credit -- has left some investors rushing out of mutual funds that invest in stocks.
Since the start of July through about mid-August, investors have removed about $15.6 billion from U.S. equity funds, according to TrimTabs Investment Research. The withdrawals put equity funds on pace for the biggest two-month outflow since September and October of 2002, when Wall Street was at the depths of a bear market.
Bond funds, meanwhile, have seen record inflows in bond flows this year, adding $94 billion, according to TrimTabs.
So while many investors seem intent on leaving stocks, those eyeing bond funds should be careful not to invest just anywhere.
"When it comes to making tactical movements, your best bet if you're not following the bond market closely is to go with a very diversified fund," said Jeff Tjornehoj, an analyst at fund-tracker Lipper Inc.
Funds that follow the Lehman Aggregate Bond Index, a widely used benchmark for the bond market, can be wise, he noted, given the index's breadth.
Even well-diversified funds that invest in quality bonds could of course suffer from market whims.
"I think they'll have very little exposure to, say, subprime paper or any sort of exotic credit derivative but that's not to say they couldn't be impacted by perceptions surrounding those instruments. If the market for bonds slips these funds aren't going to save the day," Tjornehoj said.
And funds that invest in high-quality bonds can pull back moderately if large investors are forced to sell what they can to make up for losses in lower quality and less liquid performers that aren't doing as well. Some securities made up of mortgages bundled together and sold to investors haven't done well.
"It's a carry-over effect from what is happening in areas of the market that are acutely affected," said Thalia Meehan, head of Putnam Investments' tax exempt research group, referring to some sales among higher-quality bonds.
"Trying not to panic and staying focused on the longer haul with a good asset mix tends to serve you well over the long haul for the average investor."
Meehan, who leads a team that oversees more than a dozen Putnam funds with assets of $9.3 billion, said investors should consider their investment needs but look at a fund's diversification as well as its average credit quality. Examining how well a fund has done over time can reveal whether a fund might have excelled in only one type of market.
"If you're looking for high quality funds make sure you've looked under the hood."
Robert Auwaerter, head of fixed income portfolio management at Vanguard Group, said investors might not only consider broadly diversified bond funds but even areas of the market that might have been overlooked as investors seeking quality clamored for Treasuries.
Auwaerter, who oversees Vanguard's nearly $400 billion in fixed-income assets, said many investor seeking quality funds have missed municipal bond funds.
"They've really cheapened up quite a bit," he said.
But even those looking for a broader play can still sidestep funds that have large exposure to subprime loans. A faltering housing market has led to a spike in delinquencies and hurt some of those who invest in such mortgages.
The Vanguard Total Bond Market Index fund has assets of $49.1 billion and is up 1.82 percent this year and has a five-year annualized return of 4.05 percent.
"Our bond index funds are very diversified across all the sectors of the market. Just by the nature of the indices there's really not much participation on subprime mortgages," said Auwaerter.