I Own What?! Bond Funds That Have a Taste for Stocks

Bonds are far from risk-free to begin with, but these funds have equity exposure to boot.
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Tumbling stocks have driven investors to seek refuge in bond funds this year, but if you're not careful a bond fund might give you stock exposure anyway.

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Yes, this week's I Own What?! feature has turned up a few bond funds that have at least a dime of every buck invested in stocks. How does that happen? Well, there are a variety of reasons. Sometimes a bond fund owns convertible bonds that are more profitable if converted to equities; some bond funds invest in income-paying preferred stocks. Others are simply using the vast leeway granted by most funds' legal paperwork to buy stock in companies they've studied as bond investors.

The upshot: There's nothing wrong with a fund that works from a broader palette than you'd expect from its label, as long as you know and accept that before you buy its shares.

"You just can't judge a book by its cover," says Phil Edwards, managing director of Standard & Poor's global funds research unit. "Some prospectuses are written with parameters so wide you could drive a Mack truck through them. It's important to understand how a fund manager will use that wide latitude."

We sifted the bond fund pack and found nine that have at least 10% of their assets in stocks, according to their own tally or Morningstar's, or both. Here they are, ranked by their appetite for stocks.

A few of these are "funds of funds," or mutual funds that own a blend of other funds, rather than stocks or bonds. Two examples are the

(FSFIX) - Get Report

First American Strategy Income and

(RPSIX) - Get Report

T. Rowe Price Spectrum Income funds, which had 30% and 17% of their money in stocks on June 30.

Since these funds mostly own shares of bond funds, they get bond-fund labels. Still, because of their equity tastes, they tend to be riskier than their peers, which typically sock less than 1% of their dough into stocks. Each fund has been far more volatile than its peers over the past three years, according to Morningstar. The First American fund trails 99% of its intermediate-term bond fund peers over the past three years, while the T. Rowe Price fund beats 88% of multisector bond funds over the same period.

The three Fidelity high-yield bond funds on our list show that the Boston fund behemoth isn't afraid to swing for the fences.

The

(FAGIX) - Get Report

Fidelity Capital & Income fund, run by David Glancy since 1996, and the

(SPHIX) - Get Report

Fidelity High Income fund, taken over by Fred Hoff last year, both had more than 20% of their money in stocks on July 31, according to Fidelity's most recent portfolio information.

Each fund's thumbnail description on Fidelity's Web site spells out tastes for convertible bonds, preferred stock and plain old equities. You might not expect that from a bond fund, but if their paperwork didn't clue you in, their performance would. Each fund is down about 17% over the past 12 months. That nearly doubles their average peer's tumble over the same stretch.

The junk bond market has been a wasteland for the past three years, and owning stocks like

EchoStar Communications

and DirecTV owner

Hughes Electronics

hasn't helped these funds weather the storm. Both stocks are down more than 50% over the past year.

That said, these funds' racy streaks haven't hurt them over the long haul. Both average nearly a 10% annualized gain over the past decade, topping more than 90% of their peers. The strategy isn't a lock, though. The other Fidelity fund on our list, the

(FAHBX)

Fidelity Advisor High-Yield fund run by Thomas Soviero since last year, has struggled. The fund trails its average competitor over the past one, three and five years.

All these funds underscore two timeless saws fund investors shouldn't forget: Think long and hard before you buy shares of a fund that consistently has higher highs and lower lows than its competitors, and always pick through a fund's previous shareholder reports to see where its manager might put your money.

Wide performance swings are a sure sign that a fund is investing its money in different places -- some of which you probably don't want or expect.

Ian McDonald writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to

imcdonald@thestreet.com, but he cannot give specific financial advice.