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MFS Manager Scours the Globe for Yield

Swanson aims to provide investors with a yield of 4% or 5%.

Margaret Dumont: Three months ago you promised to put me into society. In all that time, you've done nothing but draw a very handsome salary!Groucho Marx: You think that's nothing? How many men do you think draw a handsome salary? You could count them on the fingers of one hand.-- Marx Brothers, A Night at the Opera

Investors know how Groucho felt. These days even your investments are finding it hard to earn a decent salary. Good yields are scarce.

Cash will get you up to 5.25%, sure, but only for a few months. Thirty-year government bonds are paying just 4.8%, or 2.4% after inflation. High-yield debt is starting to look like medium-yield debt: The extra interest you get for the extra risk is near record lows. And dividend stocks have risen so far that the yield on State Street's

S&P Dividend SPDR

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is just 2.33%. That's less than inflation.

No wonder Boston fund company


has struck a chord with investors with its

(DIFAX) - Get MFS Diversified Income A Report

Diversified Income Fund (DIFAX), which aims to offer a decent and sustainable yield by mixing dividend stocks, REITS, government bonds, high-yield debt and emerging market bonds. It's among a wave of new products specifically designed to target retiring baby boomers by offering an income stream that might last 30 years or more.

"The aim is to give ordinary investors a yield of 4% to 5%, which is competitive with cash, but still have a growth engine in there," says MFS strategist Jim Swanson, who manages the fund. "The fund is 40% stocks, mostly income-oriented, and 60% bonds. It's not for 40 year olds, it's for 50 and 60 year olds, people who are getting close to retirement and facing this dilemma," Swanson says.

MFS launched the fund less than a year ago and it's already taken in $240 million. "For a new fund at MFS, that would be a record," Swanson says. "It's struck an amazing receptive responsive in the market place. People are frustrated with yields and bond funds and the dividend yields on stocks. They haven't seen anyone put quite this mix together." Right now the fund yields about 4.5%.

Of course, there's no alchemy available. Swanson still has to hunt around in the same asset classes for yields. His take on the opportunities?

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Right now high-yield or "junk" bonds are giving him the best juice. They make up 30% of the fund's assets, and pay out 8% a year. But Swanson sees risks ahead. High-yield bonds, which are generally issued by risky companies with a lot of debt, have become too popular, Swanson says. Even though MFS number crunchers still believe high yield is a good place to be, Swanson says you're no longer getting compensated for the risks. "There's not a lot of room for error," he says.

As a result, Swanson made a judgment call and a year ago shaved high-yield down from 35% of the fund, and he's going to continue to cut it.

(For data geeks, the average high-yield bond today pays a rate of interest that is 3.1 percentage points higher than that on federal debt. That's the lowest premium since the junk bond mania of the late 1980s. During the financial panic in the summer of 2002, by contrast, high-yield bonds were a steal, paying 12 percentage points in extra interest.)

Instead, Swanson is shifting money into bonds issued by emerging-market countries such as Brazil, Russia, Mexico and Korea. He's getting a 6.5% yield, on average.

The paradox? Swanson says emerging market debt isn't cheap. There, too, the premium over Treasuries has fallen sharply. But Swanson sees one big difference compared with U.S. high-yield debt: Emerging market debt, he believes, is safer.

"The reason I like it better is that the fundamentals there are on a long-term upward trend, whereas the U.S. high-yield market is cyclical. The credit quality that underlies these countries' bonds is actually improving over the long term."

The story is similar when Swanson looks at REITS, which make up about a sixth of the fund. "Domestic REITs are at all-time rich valuations," he says. "It's an overwrought market." Although this fund is restricted to investing in domestic REITs, he thinks there may now be better value in REITS overseas.

Swanson's also holding about 25% of the fund in stocks. Here, he says his task is easier. While yields aren't high, the fund manager is able to move up the quality ladder because shares in blue-chip companies, with solid balance sheets, are no more expensive right now than flakier small-caps. "It's a freebie," Swanson says.

Bottom line? If Jim Swanson is finding it hard to get a decent yield, it's no surprise the rest of us are having the same trouble.

MFS Diversified Income's management fees seems reasonable. The fund's expense ratio is 1%, and for that you get a lot of diversification, including international exposure, along with value-added management. Some asset classes, like emerging market bonds and international REITs, are hard to get hold of for do-it-yourselfers.

The yield, at around 4.5%, is pretty good. By contrast, Vanguard's

(VBMFX) - Get Vanguard Total Bd Mkt Index Inv Report

Total Bond Market fund (VBMFX) is only going to get you 5.0% interest, and it's all bonds, so it's vulnerable to inflation down the road.

Swanson says his strategy generally is to shift money from his highest-flying assets to the cheapest. That alone may be worth the price of admission for the millions of ordinary investors who, with the best will in the world, still find themselves doing the exact opposite.

In keeping with TSC's editorial policy, Brett Arends doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Arends takes a critical look inside mutual funds and the personal finance industry in a twice-weekly column that ranges from investment advice for the general reader to the industry's latest scoop. Prior to joining in 2006, he worked for more than two years at the Boston Herald, where he revived the paper's well-known 'On State Street' finance column and was part of a team that won two SABEW awards in 2005. He had previously written for the Daily Telegraph and Daily Mail newspapers in London, the magazine Private Eye, and for Global Agenda, the official magazine of the World Economic Summit in Davos, Switzerland. Arends has also written a book on sports 'futures' betting.