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Bond fund says worst over
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June 11, 1999: 8:19 p.m. ET
But PIMCO's Paul McCulley thinks bond yields may rise further
By Staff Writer Martine Costello
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NEW YORK (CNNfn) - As bond yields hit a 19-month high Friday, Paul McCulley of PIMCO Funds said the market's white-knuckle ride is nearly over.
"The lion's share of the bear market is over," said McCulley, executive vice president in portfolio management at PIMCO. "It's a two-part issue. Yes, the marketplace could be nasty. But there's a great deal of nastiness that's already happened in the bond market."
The bond market continued a seven-day slide Friday, pinched by a sliding dollar, ambivalent economic data and rumors. Yields, which move in the opposite direction from prices, have been rising on fears of an interest rate hike by the Federal Reserve.
The Fed kept rates steady in May but shifted its bias toward tightening in the future, meaning the central bank's next move is most likely to be an increase.
McCulley said bond yields could move up to 6.25 percent or even a little higher before edging back down.
"To say this is the last day of the bear market would be an act of hubris," McCulley said.
McCulley said he would be shocked if the Fed did not raise rates at its next meeting June 29.
"The sheer act of tightening will be viewed in the bond market as the sun coming up in the East," McCulley said.
But he said the real question is whether the Fed will raise rates more than once.
"The bond market is debating with itself what the intent of the Fed is," McCulley said. "I don't think the Fed has a multi-step process. They are taking it step by step."
Another spoiler for the U.S. bond market is news out of Japan that its economy grew at an impressive rate of 1.9 percent in the first quarter -- the first time the country's economy has advanced in 18 months. A strong economy in Japan would lure investors out of the U.S. market.
"The turnaround can't be anywhere as robust and profound as the data said this week," McCulley said about the Japan data. "At the same time, from a market perspective you have to respect that the data was above expectations. So it's a negative for bonds."
What happened to bond funds?
Bond funds soared in the second half of 1998 thanks to falling yields, said Eric Jacobson, an analyst at fund-tracker Morningstar. The yield on the 30-year bond fell as low as 4.72 percent in October. But when yields started edging up this year on inflation fears, especially for the long bond, bond funds got hit hard.
The flow of new money into bond funds weakened in April to $1.52 billion, from $6.2 billion in March, according to the Investment Company Institute, a Washington trade group.
But Jacobson said the best time to get into a high-quality bond fund is after rates are finished rising. The only trick is trying to pinpoint when the turnaround is happening -- a tough job even for a professional fund manager.
"If you believe the bond market has already seen the worst hike in yields, then that's a great time to get in," Jacobson said.
McCulley acknowledged that bond funds have been hit hard in recent months. But he said bond funds still offer a safe haven from stock market volatility for investors.
The PIMCO Total Return Bond Fund, with $25 billion in assets, is only one-third as sensitive to interest rates as the long bond, he said.
"The more the equity market outperforms the bond market, the more the equity market becomes overvalued. From a value perspective, bonds are as attractive as all get out."
The war in Yugoslavia had little impact on closed-end country funds that invest in central Europe, and the same is true about the peace agreement, said Doug Beck, senior international equity fund analyst at Merrill Lynch.
In fact, the big financial news story for the region continues to be the impact of a weak euro and flat growth in developed Europe, particularly Germany, Beck said.
"Kosovo is the tip of the iceberg," Beck said. "Below the water line …the overwhelming factor has been a depressing combination of floundering growth and a weak currency."
Yet at the same time, Merrill Lynch recently upgraded two funds that invest in the region, Central European Equity Fund (CEE) and AIM Eastern Europe Fund (GTF) to "accumulate" from "hold", Beck said. The uptick has more to do with liquidity than with Kosovo. If the Federal Reserve raises interest rates, then central Europe will do reasonably well weathering the storm.(Asia will do best, while Latin America will have most trouble, he said).
Gold fund managers may have been singing that Frank Sinatra song about "riding high in April, shot down in May."
Figures from Morningstar show that gold funds, while in the worst-performing category of the year, had a tremendous April.
All 42 funds posted gains in the month, with Rydex Precious Metals Fund up the most at 22.43 percent. A total of 37 of the 42 funds earned more than 10 percent in the month alone.
Dan Gillespie, senior portfolio manager at Rydex Funds, said commodity prices overall rose in April. Interest rates rose as well and gold historically has been a hedge against inflation.
"A lot of it was sympathy toward commodities in general," Gillespie said.
Unfortunately for gold funds, the prices have since gone back down. Almost all of the funds suffered losses of up to 18 percent in May, pushing most into the red year to date as of May 31, according to Morningstar.
"Oh well, that's life. That's what people say" as the song goes.
Tax-conscious mutual fund investors have something special to look forward to this summer besides backyard barbecues and trips to the beach.
Congress is considering a bill that would require mutual funds to disclose the tax consequences of their investing style on their performance. But the new information could come as something of a shock, mutual-fund experts say.
U.S. Rep. Paul Gillmor, R-Ohio, resubmitted the bill in March after a similar one did not survive last year's impeachment-preoccupied Congress. The bill is likely to come before Congress for a vote before the August recess, an aide said Friday.
"Taxes can be the single biggest cost of mutual funds," said Duncan Richardson, manager of Eaton Vance Tax-Managed Growth Fund. Eaton Vance has the most assets in actively managed and tax-managed funds, he said.
If you include federal and state taxes, the costs can eat up 2.5 percent of your returns a year, Richardson said.
"That's the difference between being in the middle of the pack vs. being in the top quartile" for performance, Richardson said.
There are only a handful of tax-managed funds, but the numbers are growing, fund experts say.
Richardson, who has managed the Eaton Vance fund since 1990 (Previously it was called Traditional Tax-Managed Growth Fund), said he kept turnover at a low 14 percent last year.
He sells stocks if they build up losses of 10 percent to offset gains, and he looks for stocks that he can hold at least five years. The fund, which is rated four out of five stars at Morningstar, is up 3.82 percent year to date as of Thursday. It earned 24.51 percent in 1998 and 31 percent in 1997.
And now, here are a few winners and losers for the week in bond funds, according to Lipper Analytical Services.
At the top of the list is Merriman Flexible Bond Fund, up 0.10 percent for the week June 3-10 and up 1.49 percent year to date; followed by Mitchell Hutchins Conservative Portfolio, class Y shares, which broke even for the week and lost 1.92 percent year to date; and Norwest Strategic Income Fund, class I shares, which also broke even for the week and gained 0.91 percent year to date.
At the other end of the list, the biggest loser was Smith Barney Total Return Bond Fund class L shares, off 0.83 percent for the week and down 4.80 percent year to date; followed by USAA Income Strategy Fund, down 0.58 percent this week and down 2.45 percent year to date; and MFS Research Bond Fund, class I shares, down 0.53 percent this week and down 2.81 percent year to date. 
-- Staff writer Martine Costello covers mutual funds for CNNfn.com. If you have any comments about mutual funds you can contact her at cnnfn.interact@turner.com
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