A Bond Fund Worth Watching

04/05/2013 8:30 am EST

Focus: FUNDS

Richard Band

Editor, Profitable Investing

The bond market should only lose ground gradually, but it pays to refocus on higher yields and shorter maturities, says Richard Band, who shares his top play in this field.

So Richard, interest rates are pretty low. At all-time lows, historically.

Yes, pretty close, pretty close. It's been going down for 30 years, and at some point that's going to turn around.

Right. So what does that mean for income investors? Are we getting to the point now we should start thinking about income again?

Fortunately, I don't think there's going to be a huge spike in interest rates this year. The Federal Reserve just doesn't want to see that happen, and they've been buying $85 billion worth of bonds and mortgages every month to try to keep rates from going up too fast.

So I'm not looking for a giant surge in rates this year, but it's going to happen at some point, and for that reason I think it's time for people to lay their plans and be prepared for that eventual turn, because it will catch most folks unaware.

So what do you want to do? I think what you need to do first of all is to shorten your maturities. When people hear that they say, what do you mean? The short term interest rates are almost zero, how am I going to make a living out of that?

The answer, I think, is that you have to be a little more creative, look at sectors of the bond market where the interest rates are still relatively attractive, and position yourself there.

What are some of those sectors?

Well, I'm looking particularly at the so-called high yield bonds. This would be bonds that are related below BBB by Standard & Poor's.

Are these junk bonds?

Yeah, traditionally they've been called junk. I don't really like that name, because frankly the companies that are issuing these bonds are not really junk businesses by any means. Many of them are in businesses like cable television or health care. These are businesses, legitimate businesses that are well run, it's just that they happy to carry more debt on their balance sheets than perhaps would have been considered prudent 30 or 40 years ago.

But as long as these are steady stable businesses, I am willing to purchase their debt with one proviso, and that is it's got to be short-term debt. I don't want to lend to these folks for 10, 15, 20 years. Five years or less is okay.

OK. When you analyze them, do you analyze them from a fundamental point of view?

It's hard to do that as an individual investor. However, if you buy through a good bond fund, that work is done for you. And I think it's worth going that route.

I recommend a couple of bond funds. One is an open-end bond fund, that means you can buy it directly from the fund company any day at the closing price, and that is the Wells Fargo Advantage High Income Fund (STHYX).

They maintain a short maturity. The average maturity in their bond fund is about five years...so you're not lending forever and ever and ever. But you're earning about 5.8%, which I think is very attractive in today's low-income world. And over time, I think this fund is going to produce a much higher return for you than if you, say, put your money in CDs.

And are these all corporate bonds within that?

These are all corporate bonds, and well managed. I have a little tip for your viewers, and that is look at how these bond funds performed during the financial crisis. And this is one that performed much better than its peers.

Related Reading:

Globe-Trot with This Discounted Fund

Are Higher Rates Ahead?

5 More Reasons We Favor Bond Funds

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