April 4, 2005 -- After three years of enjoying sustained gains, high-quality corporate bond and government bond funds posted a weak first quarter, suffering under the weight of rising interest rates, a surge in long-term Treasury yields, and growing fears over inflation.
The average high-quality corporate bond fund declined 0.63% in the first quarter of 2005, while the average government bond fund dropped 0.40%. However, these performance figures outpaced broad domestic equity indices.
Corporate bonds funds with shorter durations tended to outperform their longer-duration counterparts, since shorter-duration funds are less sensitive to higher interest rates.
The top-performing high-quality corporate bond fund for the quarter, the Dreyfus Institutional Yield Advantage Fund/Inv (DYAIX), seeks to maintain a minimum average credit quality of "A" and an average effective duration of one year or less.
"In the higher-quality corporate bond space, the high-beta sectors -- like autos, telecoms and cable -- were particularly weak during the first quarter, and faced selling pressure from investment-grade managers," said Kathleen Gaffney, co-manager of the Loomis Sayles Bond Fund/Retail (LSBRX).
Key to the fortunes of bonds this year will be how much the Federal Reserve raises short-term interest rates going forward, having hiked the target to 2.75% at their meeting in late March, the seventh consecutive such move since June 2004. Since that meeting, the yield on the benchmark 10-year Treasury rose as high as 4.69%.
While the central bank has seemingly committed to boosting rates at a "measured pace," further signs of inflationary pressures could compel the Fed to tighten more aggressively, thereby putting more of a damper on fixed-income performance.
Gaffney said Loomis Sayles is forecasting a target of the federal-funds rate between 3.50% and 4.00% by the end of 2005; and yield to the 10-year Treasury of between 5.00% and 5.25%. "The Fed is clearly working to move rates up, but not too fast," she said.
Standard & Poor's Investment Policy Committee believes the federal-funds rate will likely finish the year at 4.00%, with the yield on the 10-year Note at 5.00%.
| High-Quality Corporate Bond Funds | |||
| Best Performers | First Quarter 2005 Returns (%) | Worst Performers | First Quarter 2005 Returns (%) |
| Dreyfus Institutional Yield Advantage Fund/Institutional (DIYAX) |
+1.4 | Potomac Evolution Managed Bond/Investor (PEMVX) |
-4.8 |
| Calvert Social Investment Fund: Bond Portfolio/I (CBDIX) |
+1.1 | Dreyfus Premier Corporate Bond/C (DCBCX) |
-3.0 |
| Strong Ultra Short Term Income Fund/Ist (SADIX) |
+0.8 | PIF Preferred Securities/AS |
-2.5 |
| Evergreen Ultra Short Bond/I (EUBIX) |
+0.7 | TA IDEX Transamerica Flexible Income/C (IFLLX) |
-1.9 |
| STI Classic Fds Super Short Income Plus/Institutional (SISSX) |
+0.6 | Dreyfus Premier Core Bond Fund/C (DRCCX) |
-1.9 |
| Government Bond Funds | |||
| Best Performers |
First Quarter 2005 Returns (%) | Worst Performers |
First Quarter 2005 Returns (%) |
| American Century Target Maturity 2030/Inv (ACTAX) |
+6.6 | ProFunds: Rising Rates Opportunity/Sv (RRPSX) |
-1.8 |
| Potomac Contrabond Fund/Investor (PCBDX) |
+3.9 | Reynolds Balanced Fund (RBALX) |
-1.6 |
| American Century Target Maturity 2025/Inv (BTTRX) |
+3.8 | State Farm Interim Fund (SFITX) |
-1.5 |
| ProFunds:US Government Plus/Iv (GVPIX) |
+2.1 | Rydex Srs Tr:Juno Fund/C (RYJCX) |
-1.4 |
| American Century Target Maturity 2020/Inv (BTTTX) |
+1.9 | Flex-fund:US Government Bond Fund (FLXBX) |
-1.4 |
Source: Standard & Poor's. Total returns are in U.S. dollars and include reinvested dividends. Preliminary data as of 3/31/05.
Contact Bob Keane with questions or comments at:bkeane@investmentadvisor.com.
