Fed Aided Risker Bond Funds in Aug., Hurt Treasuries

Steven Bobson, Europe & Americas Editor
September 07, 2012 /

Taxable bond investors didn’t go gaga. But they were generally heartened by signals from the Federal Reserve in August.

On Aug. 22, the Fed released its minutes, showing that the central bank is leaning toward additional moves to boost the economy if it fails to show stronger growth.

That message was reinforced on Aug. 31, in remarks at the Jackson Hole, Wyo., economic summit. Fed Chairman Ben Bernanke said the central bank plans strong steps if needed to amp up the nation’s sluggish recovery.

Stocks and bonds rallied, though modestly, on both occasions. After initially pulling back on Aug. 31, 10- and 30-year Treasuries rose.

“People were persuaded that the Fed is going to take more active measures (to stimulate the economy),” said JPMorgan’s Matthew Pallai, co-manager of JPMorgan Multi-Sector Income .

The curve steepened a bit as the yield on two-year notes slipped 1 basis point to 0.219%, while the yield on 30-year Treasuries climbed 12 basis points to 2.68%.

European policymakers also did enough in August to persuade investors that they’re working on a solution to eurozone debt problems.

Encouraged, investors pushed up most taxables in the month. Riskier categories led the way. Flexible income bond funds scored a 1.26% gain on average, according to preliminary Lipper data. High-yield bond funds advanced 1.19%. Emerging-market debt funds climbed 1.11%. Treasury funds lost 0.34%.

Modest Risk

A subprime subordinated, unsecured bond owned by Pallai showed the payback for even modest risk. The bond was rated AA+ by S&P. But this Asset Backed Securities Corp. Home Equity Loan Trust bond is a nonagency mortgage securitization, which is not federally insured.

Its price rose nine points to 98.59 in August, pushing its yield down 2 basis points to 3.86%, for a total return of 0.26% vs. a 0.18% loss for the Barclays Aggregate index.

Going forward, investors expect bad news from Europe. “But as long as it’s nothing horrible, there is a lot of cash on the sidelines, waiting to be put to work in a pullback,” Pallai said.

He said he is cautiously bullish on riskier assets such as corporate bonds, high yields and mortgage backed securities whether agency backed or not.

In tax-exempt funds, low rates drove many investors down the credit curve for yield, said Peter Hayes, head of BlackRock’s municipal bond fund team. Hospital and transportation bonds take more due diligence than state bonds with lower credit risk, he said.

He found that sort of value in a Miami-Dade County transit sales tax bond with a 5% coupon, due in 2042, rated A1 by Moody’s. Its price rose 36 points to 112.56, with the yield falling 5 basis points to 3.48% for a total return of 0.68% vs. the Barclays Muni index’s 0.11%.

High-yield muni funds notched a 0.55% gain in August.

The paucity of yield also drove many income investors to the higher yield of mutual funds. Many funds hold bonds they bought when rates were higher.

Strong bond demand should blunt the historically weak-price period that starts in late September and goes into October, Hayes said. Still, he expects rising issuance this month and next. “That could lead to a bit of a correction,” he said.

 

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