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The Hazards of Bond Index Funds

During the financial crisis, government-backed mortgages held their value, but securities with no agency support sank sharply as investors worried about the high levels of defaults on subprime mortgages and other shaky assets. Figuring that the market had overreacted, Greene began scooping up mortgages that sold for 30 cents on the dollar of assets. As defaults declined, prices rallied to more than 70 cents on the dollar. "When the housing market bottomed, the valuation of the mortgages shot up," Greene says.

He still has 7% of assets in nonagency mortgages. These days the securities still yield 4% or more, a tempting yield for relatively safe investments.

Janus Flexible Bond adjusts its allocation as market conditions change. Before the financial crisis, portfolio manager Gibson Smith worried that corporate bonds had become too expensive, as confident investors bid up prices and ignored default risk. "As valuations became stretched, we sold corporate bonds and shifted to Treasuries," he says.

The move into government bonds protected shareholders during the turmoil of 2008, when the fund outdid 93% of its peers. After the downturn, Smith raised his allocation of corporate bonds. The fund currently has 58% of assets in corporate bonds. During the past five years, the fund returned 7.6% annually, outdoing 89% of peers.

At the time of publication the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine.
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