Some Top Funds Are Dumping Bonds

NEW YORK ( TheStreet) -- Bond funds have been struggling. The average intermediate-term fund dropped 1.9% during the past month. Rising interest rates have caused the losses. When rates climb, bond prices tend to fall. Is it time to start trimming your bond holdings? Some top-performing fund managers think so. These managers oversee balanced funds, which hold mixes of stocks and bonds. Lately the funds have been lowering their allocations to fixed income.

The shift by the managers is worth considering because the funds have all shown deft timing in the past. During the stock downturn of 2008, the managers moved into fixed income, helping to protect shareholders. All the funds finished in the top quarter of Morningstar's moderate allocation category for the past five years. The strong performers include Franklin Income ( FKINX), Madison Diversified Income ( MBLAX), Villere Balanced Fund ( VILLX) and Westwood Income Opportunity ( WWIAX).

Ed Perks, portfolio manager of Franklin Income, has made a particularly dramatic move. Concerned about shaky stock markets in 2011, Perks had two-thirds of assets in fixed income and one third in equities. But now he has reversed the allocations, putting about two thirds in equities. "We lost interest in fixed-income as the market went through a transition in recent years to lower yields," he says.

Perks can invest in a variety of bonds, but he is shying away from high-yield securities, which are rated below investment grade. Those now yield 5.25% -- not enough to compensate for the risks, says Perks. For extra protection, he has been trimming bonds that have maturities of more than seven years. The longer bonds tend to fall sharply when interest rates rise.

Villere Balanced can hold 25% to 40% of assets in bonds. The fund is currently near its bottom limit. "We are worried that the next move in interest rates will be up," says portfolio manager Sandy Villere, III.

Villere says that in the past month interest rates on 10-year Treasuries rose from 1.7% to 2.2%. That caused the bond prices to fall by 4%. "People who bought 10-year Treasuries a month ago have already lost two years' worth of interest," he says.

For the stock portion of his fund, Villere seeks companies that are increasing earnings at annual rates of at least 15%. He prefers to buy when the price-earnings ratio is below the growth rate. A holding is Conn's ( CONN), a Texas-based retailer that has been increasing revenue at a 25% annual rate. Focusing on low-income customers, the chain sells appliances, TVs, and bedding. While it faces competition from larger chains such as Sears ( SHLD), Conn's achieves strong profit margins by offering credit and charging steep interest rates.

Westwood Income's bond allocation has dropped steadily, falling from 40% in 2008 to 15% now. The fund aims to deliver solid income while limiting risk. To do that, portfolio manager Mark Freeman can hold a variety of assets, including dividend stocks, master limited partnerships (MLPs), and real estate investment trusts. Freeman says that bonds represent some of the worst values in his universe. "Fixed income is the lowest-yielding part of my portfolio," he says.

Freeman likes MLPs, which produce income by owning energy pipelines and other assets. Many MLPs yield more than 5%. Freeman says that pipeline companies can show healthy revenue growth as the U.S. invests to exploit growing shale fields.

Madison Diversified Income keeps half its assets in stocks and the rest in bonds when the managers have a neutral outlook. The fund currently has 58% in equities. While portfolio manager Paul Lefurgey can put up to 10% of his bond holdings in high-yield securities, he only has 1.5% of assets in securities that are rated below-investment grade. "The riskier segments of the bond markets are very aggressively priced," he says.

Madison's stock holdings include rock-solid dividend payers, such as Johnson & Johnson ( JNJ) and 3M ( MMM). Such solid companies have helped the fund outdo competitors in downturns while delivering solid results in bull markets.

At the time of publication the author had no position 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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