Bond Mutual Funds

From The Hoss's Mouth

Hoss Cents Free Money Magazine takes a look at Bond Mutual Funds (BMFs) in todays post. Bond mutual funds are a fixed income fund. The BMF manager has two basic styles to choose from when purchasing for the fund. S/he may elect spread trading, which is a conservative approach or s/he may choose an interest rate anticipation style. The other option for a BMF manager is a blend of spread trading and interest rate anticipation.

Spread Trading: The Bond Mutual Fund manager takes advantage of small or large yield changes in bonds to enhance the profits of the fund. Remember that BMFs have multi-million dollar assets and are able to take advantage of day to day yield fluctuations. Of course the bonds also accumulate interest which is paid to the fund and hence the bond mutual fund investor.

Interest-rate anticipation: Means exactly what it says. The fund manager uses various strategies and analysis to anticipate fluctuations in interest rates. Bond purchases are made on the basis of these analysis.

If the mutual bond fund manager believes interest rates will rise s/he will purchase short term bonds because they are the least effected by interest rates and can be easily sold to purchase bonds with a higher yield. If s/he foresees an interest rate drop s/he will purchase long term bonds and will benefit not only from the bond interest rate but also from the increase in value of the bond itself. (Remember that when interest rates go down bond prices generally rise).

Blend: This strategy is used often when a fund, which has a number of long term bonds in its portfolio, resorts to spread trading because the bond mutual fund manager has anticipated a decline in interest rates and needs to make adjustments in order to maximize profits. Some bond mutual fund managers will use what is referred to as a "barbell" strategy. This strategy combines a portfolio of long term bonds , short term money market holdings and no intermediate term bonds. This is very profitable when short term interest rates rise and long term rates decrease.

The Hoss reminds you that the MER of a bond mutual fund reduces the funds profits and given today's low interest rates it may be wise for the invester to evaluate whether or not the outright purchase of bonds would be more profitable than purchasing a bond mutual fund.

Stay on track,

The Hoss

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