Bond market booms on borrowing

By Russ Wiles
The Arizona Republic

Neither a borrower nor a lender be, Shakespeare warned. But that bit of advice sure has fallen on deaf ears.

At nearly $20 trillion, it's almost twice as big as the stock market, and the gap is widening.

That mortgage you refinanced last year? It probably has been sold in the bond market, which set the interest rate. If your company has a pension plan, perhaps one-third of your retirement income will be supported by bonds.

Your homeowner insurance premium may be influenced by how well your insurer fared in the bond market. Even your car loan or credit card debt may have wound up there.

Plus, the roads you drive on and the schools your kids attend probably were financed from cash raised by bonds. Municipal bonds are attractive for many individual investors because of the tax-free yields they pay.

If you fled turmoil in the stock market, you probably parked a good chunk of assets in bonds. Not only have bonds provided more stability historically, they've crushed stocks since the start of 2000.

The common thread among most debt instruments is a promise by issuers to return your original cash or principal by a future date while paying interest along the way.

Because so much of a bond's value is tied up in the future, investors get nervous when inflation percolates. This explains why bondholders often shudder over favorable economic figures while rejoicing over lower retail sales, rising unemployment and the like.

"The worse the news, the better it is for the bond market," said Todd Curtis, the Scottsdale, Ariz.-based portfolio manager of the Aquila Tax-Free Trust of Arizona, a fund holding in-state muni bonds.

Signs of economic vibrancy often foretell higher inflation and interest rates, which in turn push bond prices lower. This risk is something bond investors can't easily avoid.

But they can minimize credit risk, or the danger of defaults, by purchasing different types of bonds and those coming due at various times.

"Now more than ever, it's important to diversify bond portfolios," said Donald Cuppy, a portfolio manager at Marshall & Ilsley Trust. "Defaults and credit downgrades have increased."

Rating agencies, which are independent firms, evaluate the strength of corporations, cities, counties and other issuers, then summarize their opinions in credit ratings. Grades range from triple-A to C or D, depending on the scoring system. The key distinction is from triple-B to double-B, the border separating high-quality bonds from "junk."

Lower-rated bonds must offer higher payouts to attract investors. But they're not as safe, meaning buyers might not receive all their interest payments, let alone principal.

The risks of defaults and downgrades often keep bond-fund managers up at night, Curtis said. If a bond's rating is cut, investors will respond by bidding down its price.

Bond mutual funds typically own hundreds of bonds, greatly reducing the potential for damage if a few issuers go belly up.

Funds also are a convenient way to invest, and they generate monthly income in contrast to the semiannual interest paid by individual bonds.

But other investors and advisers prefer individual bonds to avoid the ongoing management fees charged by funds.