Treasuries, Munis Funds Gained In July Amid Bond Retreat

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Upbeat economic news late in July fueled investor worries that the Federal Reserve would speed up its timetable for hiking interest rates.

That sparked a late-month sell-off in taxable bond mutual funds , which overall lost 0.43% in July, according to preliminary Lipper Inc. data.

Service-sector indicators were up. So were factory orders.


"With the approaching end of (the Federal Reserve's) quantitative easing (program), people are edging out of rate sensitive fixed income," said Stewart Taylor, a manager of $60.5 million Eaton Vance Short Duration Real Return .

Treasuries were the only category to gain, eking out a 0.03% gain on average, as many investors sought safety amid geopolitical havoc.

Incentives for taking risk were evaporating, Taylor said. "So many investment grade corporates are fully priced. If there's no hope for further price appreciation, you tend to take profits in those names," he said.

The same retreat occurred lower on the credit quality ladder. "The lower on the quality spectrum, the worse the return was," Taylor said. "And the absolute yield of riskier segments is very low. So we started to see some profit-taking there too."

Preferring the safety of U.S. Treasuries, investors drove emerging-market local currency debt funds to a 0.91% setback.

International income funds, as a group, lost 0.63%.

Relatively risky flexible income funds backtracked 0.57%.

Yield Curve Steepened

The yield curve steepened slightly as investors fled intermediate and long bonds, driving up longer prices. More investors edged away from the long and intermediate parts of the curve. "Seven years and in have been better off," Taylor said.

The yield on two-year notes rose 6 basis points to 0.529%. The yield on 7-year notes rose 11 basis points to 2.24%. The yield on 10-year notes rose 5 basis points to 2.58%.

Going forward, Taylor is increasing his cash reserves and looking for opportunities in higher-quality corporates. He also sees some values in shorter, higher-quality commercial mortgage-backed securities ( CMBS ).

For some retail clients in separate accounts, he is creating bond ladders. Each rung has maturities of no more than five years. "This is fairly new," he said. He is putting together ladders with bonds rated BBB, yields of about 1.6% and a 2.9-year duration.

Taylor owned a 3.60% coupon bond fromWestlake Chemical ( WLK ) that matures July 15, 2022, rated Baa3 by Moody's, with a July total return of -0.10%, which was 26 basis points better than a comparable Treasury.

It benefited from its intermediate duration, relatively high quality, low natural gas prices and uptrending industry cycle, Taylor said.

Muni Moves

Tax exempt bond funds had another OK month.

Municipal bond funds overall edged up 0.11%. As in other recent months, they were driven by steady demand and low supply.

"In July we've had $23 billion in new issuance but north of $30 billion in maturities and coupon payments," said Timothy McGregor, describing monies that retail investors typically roll over into other munis.

He expects more of the same in August. "We expect $33 billion to $34 billion in reinvestment form coupons, calls and maturities, but a supply of only $25 billion to $26 billion in new issuance," he said.

But the seasonal surge of cash looking for bonds will dwindle after August, he said. Issuance could pick up too. Muni pretax yields have fallen to or below Treasury yields, making it more economical for issuers to refinance old debt, McGregor said.

"Munis are still historically cheap vs. taxables, just not as severely cheap as they were at the start of the year," he added.

McGregor owned a New York City water and sewer authority bond with a 5% coupon, 2044 maturity, 2021 call feature, rated AA+ by S&P. Its yield to call went to 3.65% from 3.80% in July. "Pretax, that's still higher than taxables," he said. Its July total return was 1.27% vs. 0.18% for the Barclays Muni Index.

There's also a good chance McGregor will be able to trade the bond in a seller's market around year-end. New York is a state whose bonds mature and pay coupons around year-end. That means a lot of Empire State investors will be looking for ways to reinvest their money in December and January.



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

Referenced Stocks: CMBS , WLK

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