Bonds thrive despite rate rises
By Meg Richards
Associated Press
NEW YORK — Bond funds enjoyed a surprisingly strong run this summer, but analysts say their advance had more to do with fear than fundamentals, as weaker-than-expected economic data and terror concerns made investors uneasy about equities.
Earlier this year, as the Federal Reserve began raising the federal funds rate off a 45-year low, many on Wall Street were predicting steep declines in the price of bonds, which fall as their yields rise.
But despite the steady upward march of short-term rates — another quarter-point hike is expected next week, bringing the rate banks charge each other on overnight loans to 1.75 percent — domestic fixed income funds are up this quarter. According to fund tracker Lipper Inc., they've risen an average of 2.77 percent since the end of June. U.S. Treasury and high-yield funds posted above-average returns, while mortgage funds were at the lower end of the spectrum.
More than half those gains came in August, when anxiety about soaring oil prices and potential attacks on the Olympics and political conventions was at its peak, prompting an investor flight to safety. Now that some of those fears have subsided or been factored in, bond prices are likely to resume their decline.
"The reason bonds have done well this quarter ... the actual technical term is risk aversion,' said Andrew Clark, a senior research analyst with Lipper. "When people are feeling fairly conservative, and risk aversion is high, that's often good news for bonds."
Investors who looked past the shower of gloomy forecasts earlier this year and held on to bonds have reason to gloat. Active investors might even consider booking some of the recent gains. After all, bonds peaked last year and are unlikely to rally further; most analysts believe they're richly valued now; and rising rates are bound to send prices lower eventually.
From a financial planning perspective, however, it would be a mistake to sell off bond funds. While it's easy to get sidetracked by returns, wise investors know that the point of holding bonds isn't so much to profit as to balance risk.
Whenever something shocks the market, Boone said, U.S. government bills, notes and bonds invariably rise in value as investors rush for the highest level of security they can find.
After Sept. 11, 2001, investors around the world bought Treasuries because of the perceived safety of U.S. government paper — even though the attacks occurred on U.S. soil. Bonds, especially Treasuries, "can be a life preserver for portfolios when people are on the verge of drowning," Boone said.
