10 Bond-Fund Refuges From Stagflation

The current dividend yields of the funds in the group, ranging from 3.19% for the Dreyfus Short-Intermediate Government Fund(DSIGX Quote) to 4.47% for the Lord Abbett Investment Trust Short Duration Income Fund(LALDX Quote), are unlikely to cover the full impact of inflation.

But because the fund managers have selected portfolios that have been appreciating in "principal" value, the funds -- while slightly riskier than Treasury bills and most money market funds -- offer reasonable hope of immunizing their holders from the erosive impact of inflation.

With every member of the list, the fund's annualized one-year standard deviation of returns -- which reflects the annualized range within which 68% of its monthly fluctuations fall -- is less than its one-year growth of principal. This raises the odds that the funds have hope of maintaining total returns sufficient to withstand the impact of stagflation.

While the dividend yields on these "principal preservation" bond funds might seem a bit anemic, investors are emphatically cautioned to resist the temptation to rush to bond funds with lofty yields in hopes of conquering inflation.

Suppose someone was convinced a year ago -- when the incipient subprime mortgage issue was just starting to cause some doubt about the viability of the financial industry and the sustainability of the bull market -- that the economic expansion would be fall into stasis with, at the same time, inflation gaining momentum.

Someone with that knowledge might have been tempted to park assets in bonds paying high yields. Big mistake!

An adjoining table shows the bond funds from TheStreet.com Ratings database with the highest dividend yields as of a year ago.

Even though the average fund on that list paid a dividend yield of 8.2%, the longer-term, lower-quality funds lost sufficient "principal" value to bring their average total investment return down to a negative10.88%. Not only did it not in any way provide any insulation from the gathering inflation, it turned out almost as poorly as the "risky" S&P 500, which tumbled 13.12% over the same stretch.

Even more damaging than the disappointing average total return of the group was the 17.91% diminution in the average "principal" value of the funds. This lowered the asset basea upon which the funds in the group depend for generating future dividend returns.

The lesson: when inflation threatens, the bond funds of choice are those with relatively short maturities, conservative portfolios and low volatility.

DISASTERS FROM LAST YEAR DEMONSTRATE PERILS OF
NAME, TICKER & TheStreet.com RATINGS GRADE	OBJECTIVE	JUNE 2007 DIV. YIELD (%)	YR.TO- DATE RET'N (%) *	12-MO. TOTAL RET'N (%) *	12 M0. PRINCIPAL CHANGE (%) *
RMK Sel High Income A (MKHIX) E-	Corporate - High Yield	11.6	-44.91	-77.11	-81.87
Universal Inst Emer Mrkt Debt II (UEDBX) C+	Emerging Mkt Income	8.6	-0.94	2.62	-4.73
DWS High Income Fund A (KHYAX) E+	Corporate - High Yield	8.3	-1.16	-3.11	-10.97
J Hancock High Yield A (JHHBX) E-	Corporate - High Yield	8.2	-14.45	-19.47	-25.09
Metropolitan West High Yield Bond M (MWHYX) C-	Corporate - High Yield	8.2	-1.24	-1.99	-10.29
CG Cap Mkt Fds-High Yield Invsts (THYUX) D	Corporate - High Yield	7.9	-1.52	-3.73	-11.69
Highland Floating Rate Advantage A (XSFRX) E-	Loan Participation	7.8	-7.59	-12.45	-19.54
Credit Suisse High Income A (CHIAX) E	Corporate - High Yield	7.8	-2.79	-4.64	-12.28
Universal Inst High Yield (UHYPX) D	Corporate - High Yield	7.7	-3.03	-1.61	-10.14
Federated High Yield Trust (FHYTX) D+	Corporate - High Yield	7.6	-2.27	-2.23	-9.42
Accessor Fd-Interm Fixed Inc Inv (AITIX) D-	Gen Bond - Inv't Grade	7.6	-6.02	-3.30	-8.38
UBS High Yield A (BNHYX) E+	Corporate - High Yield	7.6	-1.64	-3.55	-10.55
AVERAGES FOR ABOVE FUNDS		8.2	-7.30	-10.88	-17.91
* For period ended 6/30/2008. Source: TheStreet.com Ratings - Data as of 6/30/2007. For an explanation of our ratings, click here.