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10 Most Highly Rated Bond Funds

Kevin Baker

When your focus changes from return on your money to return of your money, it's time to look at the highest-rated bond funds.

After the evisceration of Lehman Brothers(LEH Quote), Merrill Lynch(MER Quote) and AIG(AIG Quote), fear is trumping greed on Wall Street. The Dow Jones Industrials, as measured by the Diamonds Trust(DIA Quote), and the S&P 500, using the SPDR Trust Series 1(SPY Quote) as a gauge, have each tumbled more than 15% from the beginning of the year.

As a result, investors are reassessing their asset allocation between equities and bonds.

Below are the 10 most highly rated bond funds that have consistently generated positive, albeit small, returns for shareholders over the past three years, each earning a rating of A+. All are classified as municipal funds, which mainly buy revenue bonds and other debt tied to government-works projects.

Topping the list is the Wells Fargo Advantage Ultra Short-Term Municipal Income Fund(SMUAX Quote), which seeks capital preservation with current income-generating investments exempt from federal taxes. For safety's sake, the fund limits its dollar-weighted average maturity to one year or less. As of July 31, the fund had 270 securities with a turnover rate of 192%. The largest holdings include California's tobacco settlement, a north Texas toll road, New York's Triborough Bridge andTunnel, and hospitals in Rhode Island and Arkansas.

No. 2 is the Vanguard Short-term Tax-Exempt Fund(VWSTX Quote). The fund is similar in focus on federal tax-exempt income and capital preservation but extends the average maturity to between one and two years. The current average maturity is 1.2 years. Big picks include the Pennsylvania Turnpike, Las Vegas Water and the Florida Hurricane Catastrophe Fund.

The third-ranked Alpine Ultra Short Tax Optimized Income Fund(ATOIX Quote) stretches the target maturity to as far as three years, allocated to 62.5% variable rate demand notes, 13% auction rate notes, 11.5% municipal bonds, 9.7% put bonds and 3.3% general market notes. The three biggest holdings are 7% in Volusia County Multifamily Housing, 4.6% in Sunshine State Governmental Financing Commission and 4.2% in the Scottsdale Industrial Development Authority.

For an explanation of our ratings, click here.