Treasuries, High-Yield Bonds, Munis Rose In Aug.


Coming off July's setbacks in nearly all categories, taxable bonds rallied in August.

They marched to a tandem of drummers. Investors spooked by geopolitical tumult sought safe havens. That pushed Treasury funds up 2.40% on average last month, according to preliminary Lipper Inc. data.

Investors who were more concerned with finding income crowded into categories such as high-yield funds, which jumped 1.22%.

Investors largely avoided Europe and other foreign locales. Emerging markets local currency funds eked out a 0.44% gain. Foreign income funds edged up 0.63%.

Domestic categories fared far better. Corporate triple-B rated funds gained 1.52%. Corporate single-A rated funds rose 1.25%.

"It's a flight to safety," said Arne Espe, manager of the $187 million USAA Flexible Income Fund . "It's driven by Europe. To anyone looking for safety, our market looks somewhat better for a couple of reasons. Yields are higher." The German bund was down to about 90 basis points. France was around 125. Those were much lower than the 10-year Treasury, whose yield was 2.35% as of Aug. 29.

Worse for Europe, the euro has been weakening. "And there's a lot of bearish sentiment. A lot of people think it will continue to weaken," Espe said.

Also, the U.S. economy is faring better.

The flight to safety helped longer duration bonds, especially Treasuries, Espe added. Jittery investors wanted to park their money someplace safe for an extended period.

That pursuit of a safe haven caused the yield curve to flatten. The yield on 10-year notes fell 23 basis points to 2.35% as prices rose. The yield on 2-year notes fell 5 basis points to 0.48%.

Espe expects rates to rise during the next one to three years. As a result, he is shifting into shorter duration debt.

His fund's average duration is about two years. The Barclays Aggregate Index's is more than five years.

He sees the high-yield market as fully valued in general. "But we've found pockets (worth owning) in investment-grade and high-yield bonds," he said. "The pockets are in the energy space and some gold mining companies and commercial mortgage-backed securities. Also, some investment-grade financials, like insurance companies."

In August, he owned debt from St. Barbara, an Australian gold miner. The five-year bonds mature in April 2018. They have an 8.875% coupon.

Their August total return was 4.07% as their price yield to maturity fell to 15.57%, down from 16.48% on July 31.

Moody's rated the bond Caa1. "With a yield near 16% it's almost trading at a distressed level, which is generally anything trading 10 (percentage points) over the Treasury," Espe said. That's usually a sign that the market expects the issuer to default. "But we don't expect a default, and we're getting three times the yield of the average high-yield bond," he added. Providing added security, the bond is secured.

The bond's yield is so high because it is a small issuer that is relatively unknown, Espe said. And gold mining is very out of favor.

The Muni Market

Tax-exempt funds rose 1.26% in August on average.

Tight supply was the main story, said Chris Ryon, co-manager of three Thornburg funds, including the $6.9 billion Limited-Term Muni .

Muni funds have seen net shareholder inflow for seven straight months through July, according to the Investment Company Institute. That follows 10 months in a row of outflow.

So muni bonds have started to look richly valued to Ryon. As a result, he is lowering the durations of his funds. "We're not getting paid to take risk, so why take more risk?" he said.

As the year progresses, Ryon expects more issuers to try to tap into the steady demand. Issuers will also want to sell bonds before the Federal Reserve increases rates, which Ryon says could begin in the next six to nine months. "Supply should pick up throughout Q4 as issuers come to market," he said.

Ryon owned a bond for the Poseidon Resources desalinization plant in Southern California, maturing in 2045, rated Baa+ by Moody's, with a 5% coupon. With its yield going to 4.29% from 4.60% last month, its total return was 2.47% vs. 1.31% for the Bank of America/Merrill Lynch muni index.

Investors bid up the bond due to its unusually strong yield to maturity for a long bond.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

This article appears in: Investing , Mutual Funds

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