Band Bets on Bonds

03/10/2006 12:00 am EST

Focus:

Richard Band

Editor, Profitable Investing

"I strongly suspect we’re counting down to a blastoff for bond prices," advises Richard Band. "I recommend at least a modest dollop of long-dated Treasuries for almost any safety-minded investor." Here, he offers some favorite bond funds to add safety to your portfolio.

"All around us, evidence is mounting that the Federal Reserve’s increasingly tight monetary policy is starting to bite into economic activity. By mid-year, I predict, everybody will be talking about the slowdown—and T-bond yields will have begun their descent toward multi-decade lows. (Remember that bond prices rise as yields fall.) Where are the signs that business is slackening? Consider just a handful:

  • Gross domestic product (GDP), the sum of the nation’s output of goods and services, grew at an anemic 1.1% annual rate in the fourth quarter of 2005, down from 4.1% the previous quarter and well below economists’ projections.
  • Mortgage refinancings, which enabled consumers to spend more than they earned in 2005, have skidded 28% in the past year. The decline is accelerating.
  • Job growth, already the slowest of any economic expansion since the 1940s, peaked over a year ago (based on the 12-month percent change in payrolls). If the job machine sputters, the whole economy will feel the impact.

"Please, I’m not a gloom-and-doomer. However, it’s nice to know that we’ve got Treasury bonds to protect us if the economic going gets tough. History suggests, in fact, that our Treasuries will shine brightest right when other investments (such as stocks, real estate or gold) are faring worst. Thus, they provide an excellent stabilizer for our portfolio. With that thought in mind, here, are two of your best options:

"Wasatch-Hoisington US Treasury Fund (WHOSX) is a no-load fund that is great for one-stop shopping. Skipper Van Hoisington has positioned the fund aggressively in longer maturities, with 44.5% of the portfolio in zero coupon bonds as of September 30 (the last public report). The rest of the portfolio consists of plain-vanilla T-bonds maturing in 20 years or more. Because WHOSX pays only one distribution per year (in December), investors who need current income should choose the Vanguard or iShares funds highlighted below.

"American Century Target Maturities Trust—2025 Portfolio (BTTRX ) offers maximum punch, you want to own some zero coupons. These bonds pay no current interest, so they’re a pure play for capital gains. If bond yields drop 1% across the board in the coming year, the American Century 2025 fund will chalk up a return of approximately 25% after expenses.

"BTTRX declares a taxable distribution each year, reflecting the theoretical amount (calculated according to Uncle Sam’s rules) by which the zeros appreciated on their way to maturity. To spare yourself this annoyance, it’s smart to hold the fund inside an IRA or other tax-sheltered retirement vehicle.

"In addition, for retirees and others who depend on interest income to pay the grocery bill, I’ve got two alternatives to the funds just listed. Both of the following T-bond funds send out monthly checks, with a current yield in the neighborhood of 4.5% to 4.6%:

"iShares Lehman 20+ Years Treasury Bond Fund (TLT ASE), like other exchange traded funds, can be bought or sold instantly, throughout the trading day, using any stockbroker. You can also specify the price you’re willing to accept (via a limit order). TLT features an ultra-low expense ratio of only 15 cents a year per $100 invested.

"Vanguard Long-Term US Treasury Fund (VUSTX) is a traditional mutual fund with end-of-day pricing. There’s no sales charge and, if you buy directly from Vanguard, you avoid brokers’ transaction fees. Far more frugal than most actively managed bond funds, Vanguard Long-Term US Treasury runs up annual expenses of only 24 cents per $100 invested.

"Our advice is for investors to keep buying Wasatch-Hoisington US Treasury Fund and American Century Target Maturities Trust—2025 Portfolio any day that the ten-year Treasury note is quoted at 4.5% or higher. I advise putting $3 into Wasatch, the steadier fund, for every $1 in American Century. For monthly income, I also recommend buying the iShares 20+ Years Treasury or Vanguard Long Term on any day the ten-year Treasury yield stands at 4.5% or higher. If you wish to place a limit order for TLT, set your price at $90.40 or less."

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