Top Bond Funds Aren't for the Risk-Averse

The top-performing sectors for bond funds in the second quarter focused on funds that invested in floating-rate loans and other floating-rate securities, and those that invested in senior secured floating-rate securities.

In general, the mandate of these funds is to seek current income and have capital preservation as a secondary criterion. This obviously isn't the type of fund for risk-averse investors.

These funds are classified as either loan-participation funds or corporate high-yield by ratings classifications used by TheStreet.com. The average return for each of these categories was 2.17% and 1.22%, respectively, for the three months ended June 30.

The best-performing funds were the ING Senior Income Fund(XSIAX Quote) (6.11%), the Eaton Vance Floating Rate Advantage fund(EAFAX Quote) (5.91%) and the AIM Floating Rate fund(AFRAX Quote) (5.73%).

Chasing yield or income on its own, with a secondary commitment to capital preservation, is for a certain type of "opportunistic" investor, given the volatility and uncertainty in markets at present. This is akin to being a fox in a henhouse -- you want to make sure you get out before anyone notices.

Should markets continue to deteriorate, investors who are exposed to these types of funds will be punished for their lack of attention to capital preservation. Also, it's almost illogical at a time like this to be chasing such a low yield of, say, 6% at the risk of a far greater percentage fall in one's capital base. Investors should always look at the risk being taken vs. the potential return.

It would be less risky to chase a lower yield of, say, 4% with far greater capital preservation potential as offered by utility funds.

So in the example above, an investor looking to invest in, say, a loan participation fund and chase a 6% yield is taking on a disproportionate level of risk for the additional 2% yield, when there exists a 4% yield in a utility fund that takes income and capital preservation as equal considerations.