It's still not too late to sell your bond funds, say investment experts who see even higher interest rates ahead.
In the first nine months of 1994, Americans yanked a net $35.7 billion from mutual funds that invest primarily in bonds as rates rose and prices tumbled. That's pocket change, however: some $539.6 billion remained, according to the Investment Company Institute.
Stubborn bond investors could be in for further bludgeoning. "You've still got more losses ahead in your bond account," said David M. Jones, chief economist at Aubrey G. Lanston & Co. "Sell your long-term bonds and move into shorter-term."
Almost no one disputes that the Federal Reserve Board -- which has raised short-term interest rates five times since Feb. 4, for a total of 1.75 percentage points -- has more work to do in fighting inflation, or at least its specter.
"We think the Fed probably has about another 100 to 125 basis points worth of tightening over the next 12 months," said Ian A. MacKinnon, director of the fixed-income group of the Vanguard Group.
Many Fed watchers expect 50 of those points, or half a percentage point, to come when the Federal Open Market Committee meets on Nov. 15. If long-term interest rates, which so far have moved in tandem with the short end, rise a total of another 1 1/4 points, that would carve $12 or so from the price of a 30-year Treasury bond, which stood at $94.50 at the end of October.
A drop that large from that price would potentially erode another 12.7 percent of the capital value of a long-term government bond fund.
If long-term bonds seem a foolish bet right now, there are options.
Mary Coughlin, head of the investment-grade fixed-income group Lehman Brothers Global Asset Management, recommends moving into intermediate-term bond funds. "And I would include in those a fund that buys some lower-rated paper," she added, "because if the economy is doing better, junk bonds should do better."
Shortening the average maturity of bond holdings in the current market preserves much of the yield of longer issues with significantly less risk. A five-year Treasury note bond captures 93 percent of the yield of a 30-year issue, MacKinnon said, "and the price volatility is only about 35 percent or 40 percent as much."
Junk bonds are appealing because they are tied more to the fortunes of the issuer than to interest rates, and a stronger economy is already lifting them.
Northeast Investors Trust was the top corporate high-yield bond fund the last 12 months, with a total return of 8.34 percent through Oct. 28. With an average maturity of about seven years, the fund is concentrated in junk bonds, though 20 percent of its $581.7 million in assets is in common stock.
Its manager, Ernest E. Monrad, said the current worldwide economic growth has raised the demand for capital and thus the pressure on rates. "That is a gloomy prospect for the high-grade market, but it would be good for us because our bonds do better in economic good times," he said.
A year ago, some fixed-income advisers were diverting long-term funds overseas because of the weakness of the Japanese and European economies. Foreign markets have largely moved in lock step with the United States, but international bonds still are recommended by some experts.
"World government bonds will be a source of compensatory returns over the next year," said Edgar M. Reed, chief investment officer of Back Bay Advisors, based in Boston.
Investors who have suffered real losses this year should "absolutely" consider selling their bond funds if they can offset other gains for tax purposes, MacKinnon said. Assuming proceeds are reinvested in different funds, like intermediate-term, junk or foreign bonds, investors are not likely to run afoul of Internal Revenue Service rules prohibiting "wash" sales.
Before investors buy other bond funds, they should learn if those funds will make distributions of realized capital gains in coming weeks and should only buy after the payout to avoid taxes on those gains.
Some investors may want to sit tight a while because events could confound bond experts in two ways: the Fed could be done with rate-raising, and its action on Nov. 15 would provide a clue to that, or further increases in short-term rates could prove so reassuring to investors that long rates fall.
Mr. Reed says inflation will not be as severe this cycle as in the past. "Whenever the peak of interest rates occurs," he said, "it won't be in double digits."
Ms. Coughlin of Lehman said she would probably advise long-term investors to "sit tight." In times of uncertainty, she said, "it's better to wait until you have a firm opinion. Unless, of course, you're sitting in front of a moving train."