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What Bond Mutual Funds Are Not Telling You

February 26, 2013

A previous blog expressed some of the danger in owning bond mutual funds.  Now, I want to share with you what bond funds are not telling you.  Some of these may influence your decision to own them.


In addition to a complete prospectus, most bond mutual funds issue a two page summary or “sell sheet” describing the fund.  Near the top of the sheet is the “Objective” and many say “Current Income.”  That is reasonable.  However, I have a few such sheets in my hand and do not easily see what the current income


The sheets have the “investment performance” or “total return” for the most recent quarter, year to date, and 1-year, 2-years, up to 10-years.  And, this performance is quite impressive for the last few years; but not too impressive going back to the last full five and ten years.  A reason for this, is that interest rates tanked during the last five years causing bond values in the funds to increase… resulting in the imposing performance.  In actuality, many of the strongly performing bond funds made distributions less than 2.5% during these periods and presently pay less than 1.5%.  The funds do not list the historic dividend payout; only the total return.  The mantra of many bond funds is now to chase total return rather than cash distributions. This makes many of their investment decisions contrary to their stated objective of current income.


So, what’s with the high total returns they are bragging about?  The high total returns were due to dropping interest rates.  As rates decreased, the value of the bonds in the funds increased.  Reason tells us that the opposite will occur if rates ever increase.  I don’t know if rates will increase, but if they do, the value of the bond funds will decrease causing very low total returns at best and negative returns as a probable result.  This can be seen somewhat on the fund’s own sell sheets.  Look at the 10-year performance.  If that is less than the 5-year performance, it means that the performance for years 6 through 10 must have been much lower than their average 10-year performance.


What I would like to know is what the annual coupon interest is based on the bonds currently in the portfolio.  That is the cash flow you can expect.  I don’t believe it will be anywhere close to the “performance” in any period during the last five years.


If the objective is current income, why don’t they feature the current income distribution?

One Comment leave one →
  1. shalomray permalink
    February 26, 2013 1:47 pm

    The problem with bond mutual funds is that they are an ever-changing pool of assets. When you own one or two or ten bonds, you have control over each individual investment. Knowing when to hold ’em and when to fold ’em is the key, of course, but you are still in control. When yields are up and values are down, you can still opt to hold a bond until maturity and get back the face amount. Not so with funds. IMHO, holding bond funds turns these fixed income assets into something more akin to equities, with no real maturity date. I don’t write them off completely (I own some in my own portfolio) but you have to understand and compensate for their shortcomings.

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