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MUTUAL MONITOR Why bond schemes are best to beat the bears with. By Dhirendra Kumar
Unlike their equity fund counterparts, they're not glamorous. Bond-fund managers are rarely sought after for their views. Since the bond funds' long-term returns are lower than the stockmarkets', investors have simply no use for them. When the stockmarkets soar, even a mediocre equity fund can make the best bond fund look like an also-ran. Yet, in calendar 1997, the bond funds actually outperformed the stock funds and, in the process, earned their place in the sun. When stockmarkets struggle, bond funds have their utility. They make a lot of sense for investors with a short time-horizon. They offer diversification for a stock-heavy portfolio. Cautious investors load up their portfolios with bond funds because they believe they can't lose money with bonds; that they are a risk-free investment. Is that right? Wrong. While fixed-income funds are less volatile than stocks, there's many a risk associated with bond investing. In the bonds markets, you are exposed to, at least, two significant risks: interest-rate risk, and credit risk. If you own a bond with a 12 per cent coupon, and the interest rates rise to 13 per cent, your 12 per cent bond becomes less attractive. Conversely, if you own a bond that pays 13 per cent, and the going rate is 12 per cent, your bond is worth a little more. A bond's interest rate sensitivity is also affected by its maturity--the time before the bond matures, and pays back the principal to the bondholder. The longer the maturity, the more sensitive it is to fluctuations in the interest rate. The other risk is the credit risk. Bonds issued by companies bear some degree of default risk. A lower credit rating, generally, has a higher coupon rate, and vice-versa. Then, bond ratings can be raised or lowered during the life of the bond. When the ratings change, the value of the bond changes as well. Funds which hold a large number of lower-rated issues--the so-called high-yield funds--can get rocked if the ratings of their bonds are lowered. Or issuers default, which can be the case if the economy goes into a recession. In all, there are 15 open-end bond funds available today, with an assortment of risk and return profiles. While making your pick, do not ignore one crucial factor: expense. Or the fund manager's fees, and the entry and exit loads. As a rule, steer clear of funds with any entry load or a steep exit load. After all, a bond could also mean bondage |
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Bonds, if they're not James, get no
respect. 