Running from risk

There was a time when triple-B-rated corporate bonds could pass for investment grade, but it seems long ago. While one- to ten-year A-rated corporates yield about 3.9 percent, their medium-quality counterparts, on the cusp of junk, yield 5.8 percent or so.

There was a time when triple-B-rated corporate bonds could pass for investment grade, but it seems long ago. While one- to ten-year A-rated corporates yield about 3.9 percent, their medium-quality counterparts, on the cusp of junk, yield 5.8 percent or so.

Avoiding the blowups and downgrades that have littered the corporate bond market is the key reason better-quality corporate funds, which Morningstar defines as A-rated or higher, have delivered handsome returns. Successful managers have also proved adept at diversifying their portfolios with mortgage-backed securities and Treasuries. According to Morningstar, bonds rated A or higher returned 5.5 percent through November 15, following a 7.3 percent return in 2001.

The Morgan Stanley Institutional Investment Grade Fixed Income and Institutional U.S. Core Fixed Income funds returned 6.1 percent and 6.6 percent, respectively, through November 15, while the Calvert Social Investment Fund Bond Portfolio delivered a 5.2 percent return for the same period. Last year these three funds racked up double-digit gains.

Not surprisingly, cash has flooded into the sector in the past two years. According to Boston-based Financial Research Corp., the industry’s 140 high-quality corporate bond funds attracted some $11.5 billion in new cash in 2001, compared with an outflow of $170 million in 2000. At the end of September, the same funds had already pulled in $13.3 billion in net new cash.

“Last year high-quality corporate funds benefited from falling interest rates, beating many other funds,” explains Morningstar analyst Scott Berry. “This year funds that invest in bonds rated A or higher are winning, due to more accounting issues at companies like WorldCom and a slowing economy.”

Quality is king at Bethesda, Marylandbased Calvert Social Investment Fund, which returned 14 percent in 2001. Chief investment officer Reno Martini scouts out bonds rated A or double-A for his 60-bond, socially responsible portfolio. “Credit markets are having downgrades galore,” he says. “So we decided to play it close to the vest. We look for value.”

Martini favors conservative names: Some 12 percent of the fund’s assets are stashed in insurance bonds from solid issuers like Atlantic Mutual Cos., Liberty Mutual Insurance Cos. and Prudential Financial.

Other winning funds are also reaching beyond corporates. Steve Esser, corporate bond team leader at Morgan Stanley, has 50 percent of his funds invested in mortgage-backed securities, but just 22 percent in corporate bonds. And to lessen credit risk, he caps his individual bond investments at 1 percent of fund assets and avoids risky sectors like utilities and telecommunications. “We’re over-weight in insurance,” he notes.

At Philadelphia-based Scudder Fixed Income Fund (Institutional), portfolio manager Gary Bartlett has invested only one third of his $836.7 million fund in corporate bonds. The rest is in mortgage-backed securities and commercial paper. “There are worries in the market about the abilities of some corporations to finance,” he says. “Clearly, they are the most difficult.”

Meanwhile, at the world’s leading bond shop, Newport Beach, Californiabased Pimco, John Brynjolfsson, portfolio manager of the $5.9 billion Real Return Fund, has 95 percent of his fund invested in Treasury inflation-protected securities, or Tips. He sees the 30-year Tips as the most compelling investment. His fund is up 13.2 percent through November 15, so his opinion carries some weight.

Funds scoreboard
Morningstar ranks the following as 2001’s top ten high-quality institutional bond funds.
Fund Total return calendar year 2001 Total return year-to-date 11/15/02 Assets 11/15/02 ($ millions)
Calvert Social Inv. Fund Bond Portfolio 14.0% 5.2% $ 156.7
Morgan Stanley Inst’l Inv. Grade FI Fund 11.0 6.1 283.4
Morgan Stanley Inst’l U.S. Core FI Fund 10.6 6.6 322.3
Scudder Fixed Income Fund (Inst’l) 9.3 7.1 836.7
Armada Limited Maturity Bond Fund (I) 9.2 4.3 256.3
One Group Bond Fund (I) 9.1 8.2 3,767.7
STI Classic Inv. Grade Bond Fund (Inv.) 9.1 5.1 909.9
Pimco Real Return Fund (Inst’l) 8.7 13.2 5,913.5
Payden Short Bond Fund 8.6 5.2 180.3
ING Bond Fund (I) 8.6 6.2 123.9
Source: Morningstar.
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