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Four Fixed-Income Funds to Add to Your Portfolio

As the bond market works through a major distortion, here are some safe plays that will still make money.

There is not enough coverage given to the fixed-income portion of a diversified portfolio, so this seems as good a time as any to do a checkup.

The bond market is currently working through a huge distortion, wherein Treasury yields are so low that Bill Gross has called them the most overpriced market on the planet; municipal bonds yield more than Treasurys (this should not be because of the tax-advantaged nature of munis) and the spread in yields between Treasurys and lower quality paper have been extremely volatile.

While I don't think a fully invested position is ideal right now, there are some parts of the bond market that can offer some decent value and reasonable yields.

Vanguard GNMA Fund

(VFIIX) - Get Free Report


just profiled this fund favorably, and I think it's right.

The mortgage market has been a mess for over a year now, but GNMA pools -- the type of mortgage product that underlies this fund -- is a different segment of the market mortgage market than most of what has been in the news. GNMA bonds are backed by the U.S. government.

The fund yields 5% and has an expense ratio of 0.21% which is low even for bond funds.

MFS Intermediate Income Fund

(MIN) - Get Free Report

MIN has been around for 20 years, and mostly owns a mix of mortgages, U.S. Treasury and agency debt and sovereign debt from foreign countries. As of March 31, 83% of the holdings were AAA.

For the trailing 12 months, the fund has yielded 5.5%, and it currently has a 9.4% discount to NAV. I would not expect that discount to narrow anytime soon -- MIN has traded at roughly a 10% discount since 1994.

One other point about MIN is that it can leverage up to one-third of its assets, but as of its latest reports, the fund is not levered. The fund may seem expensive, though, at 0.75%.

Pimco Developing Local Markets




first wrote about this fund

a year and a half ago. The fund is more of a foreign currency fund, with 64% of its holdings maturing in one year or less.

The fund is heaviest in Poland, Singapore, Mexico and Hong Kong. All four markets offer offsetting traits that I believe help neutralize the inherent risks which have allowed the fund to generally go up as the dollar has weakened.

The fund yields 4.33%, and while the 0.85% expense ratio may seem high, it is true that a fund trading foreign bonds is going to encounter more expenses than a domestic bond fund. Obviously, a rebound in the dollar would hurt this fund.

Lehman Credit Bond Fund


CFT is a mishmash of dollar-denominated debt, including U.S. corporates from divergent sectors and foreign debt (as long as it is denominated in U.S. dollars). CFT yields a little over 5%, has an average credit rating of BBB+.

The fee is very low, at 0.20%, and the weighted average maturity is 9.57 years, with an effective duration of 5.94 years.

One last possibility to explore is individual Treasury issues from foreign countries. They are actually quite easy to buy and very liquid. Higher yields are available without having to go to emerging-market paper and, unlike a bond fund, there is a par value that an issue must return to at maturity.

The one obstacle is that the minimum order size is usually $100,000.

I would not suggest exceeding more than 10% of a fixed-income portfolio with any single holding, so an individual investor should have a fixed-income portfolio of at least $1 million to participate in this market. Or, your adviser (if you have one) could possibly buy for many clients at the same time, making smaller allocations possible.

It is very unlikely that bonds (referring to the entire asset class) can outperform equities over the long term. With that understanding, the biggest reason for owning bonds becomes offsetting the volatility of equity portion of a diversified portfolio.

Given the distortion in the fixed-income market caused by abnormally low Treasury yields, the bond market should be thought of as being unusually risky these days.

If you look at any of the funds listed above, you might be struck by how boring they appear to be -- which is exactly the part of the bond market to be in because of the heightened risk.

At the time of publication, Nusbaum was long VFIIX, MIN and PLMIX on behalf of clients, although positions may change at any time.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback;

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