Maybe it didn't feel like it. But taxable bond funds on
average eked out a gain in the third quarter.
They advanced 0.93% on the strength of a 1.06% gain in
September, according to preliminary Lipper Inc. data, and 0.49%
in July. They lost 0.69% in August.
The sometimes upside-down way bond investors reacted to
certain Q3 news would have looked familiar to Alice as she
wandered through Wonderland.
"September in particular was almost a bad-news-is-good-news
month," said Charles Burge, senior manager of $567 million
Invesco Core Plus Bond Fund . "The economy was doing poorly
enough that the Federal Reserve could not begin to taper its bond
buys. That was good news for risk assets."
In May and June, Fed Chairman Ben Bernanke led many investors
to think the central bank would start to trim its easy money
policy in September. Those investors were surprised when the Fed
got cold feet on Sept. 18 and stuck to its monthly buys of $85
billion in Treasuries and mortgage-backed securities.
Treasury funds rallied and finished the month up 0.89%, but
still down 0.62% for Q3.
Riskier Bonds Rose
The Fed's accommodative stance also enabled spread products
like high-yield bond funds to soar 1.00% last month and 2.21% for
Corporate BBB-rated funds tacked on 0.99% last month and 0.69%
Foreign debt funds jumped 2.27% in September, leaving them up
2.12% for Q3.
"Foreign bonds had lagged and were due for a catch-up," Burge
The yield curve steepened slightly, reflecting taxables'
rollercoaster quarter. Two-year notes sagged 3 basis points to
0.33% but had peaked at 0.52% on Sept. 5.
Ten-year notes edged up 12 basis points to 2.64%. They peaked
at 2.98% on Sept. 5.
Burge bought some Verizon bonds in the telecom's
record-setting corporate issue of $49 billion on Sept. 11.
The deal was intended to help Verizon buy the portion of its
U.S. wireless business owned by Vodafone.
Verizon sold bonds along several parts of the curve. Burge
went for 20-year ones at a price of 99.9. Burge found the yield
of 6.41% attractive, a spread of 250 basis points over the
It was rated Baa1 by Moody's.
Demand was so high -- more than $100 billion in orders were
placed -- that a planned offering in Europe was dropped. "The
fact that there is so much demand is positive," Burge said.
By month end it was trading at 110.07, with a yield of 5.48%,
a spread of 175 basis points.
Tilt Toward Quality
Burge's outlook for taxables is fairly positive. But the delay
in the start of tapering could magnify the market's response when
the move is eventually made, he said.
For now, he sees opportunities in spread products, especially
corporates. "We like being long duration," he said. He's been
buying A-rated, BBB-rated and high yields.
He's been trimming exposure to emerging markets.
General municipal debt funds lost 1.32% on average in Q3
despite gaining 2.32% in September.
Detroit's July 18 bankruptcy filing was the first blow. Next,
worries surfaced the last week of August that Puerto Rico would
suffer a similar fate. "Everyone owns Puerto Rico bonds," said
Alex Grant, manager of $341 million RS Tax Exempt Fund and of
$154 million High Income Municipal . "It's one of the largest
issuers. Many funds use that as a substitute for in-state
Mounting investor fears drove down the price of the S&P
Puerto Rico Municipal Bond Index 20% off its May 21 high and 14%
in Q3 alone. Its Q3 yield soared to 6.73% from 4.9%. The yield
for the S&P National Muni Bond Index rose only to 3.04% from
And fears of Fed tapering re-flared in early September. The
central bank was widely expected to announce the start of
tapering at last month's FOMC meeting.
Shareholder response is reflected in the 17 weeks in a row of
muni-fund outflow through Sept. 18, according to the Investment
The beatdown of Puerto Rico bonds in particular and munis in
general finally attracted buyers who are not traditionally big
players in munis, including insurance companies, crossover buyers
(taxable investors lured by munis' yields and tax benefits),
hedge funds and buyers specializing in distressed issues, Grant
said. Those buyers were the backbone of the September rally.
Munis' rollercoaster ride was illustrated by a California
general obligation bond that Grant bought on Aug. 20. It had a
5.25% coupon and matures April 1, 2035. He paid 103.14, yielding
On Sept. 5, its worst Q3 day, it was priced 101.99 to yield
But by Sept. 30 it had rallied to 106.26, yielding 4.36%.
Grant expects continued volatility in tax-exempts until the
Fed clarifies its tapering timetable. He is tilting more toward
high grades and shortening his duration.