NEW YORK -- The squalls that have rolled over Wall Street since stocks sold off in late February have sent some investors looking to shore up their portfolios with bond funds. But for many, simply moving into bonds won't afford as much diversification as they might think.
The Feb. 27 sell-off, which shaved more than 3 percent from major U.S. stock indexes, ushered volatility back to Wall Street following unusual calm during the second half of 2006. It left behind frayed nerves, as well as a fresh set of questions about how well some investors were diversified.
Some investors apparently felt exposed and sought safety. From March 1 through Monday, investors put $5.66 billion into bond mutual funds, according to data from Trim Tabs Investment Research.
During the same time, investors pulled $1.03 billion from U.S. equities funds.
The February sell-off, as well as emerging concerns about subprime mortgage lenders, which make loans to people with poor credit, have buffeted investor sentiment. Later, comments from the Federal Reserve that Wall Street regarded as favorable for interest rates helped restore some of the wealth lost following the late February pullback. Nevertheless, investors still went on an up-and-down ride.
So with volatility, a regular character on Wall Street, back indefinitely, investors looking at the fixed-income market for safety and stability should first consider what types of bonds they might need. Types range from the safest government Treasury notes to high-yield, or junk, bonds, which carry more risk.
Greg Hopper, portfolio manager of the Julius Baer Global High Income Fund, still sees opportunity in the high-yield market. He contends investors' unease about high-yield bonds amid a slowing economy has been overblown.
"I think people are way too concerned about high yield. Default rates are bumping along at 2 percent, very low historically," he said. "Corporate cash flows are still quite healthy. The U.S. economy is slowing, but it's not going into recession."
Scott Berry, senior fund analyst at investment research provider Morningstar Inc., notes that while high-yield bonds have been the best performing type of bond funds this year, investors considering bond funds should remember to diversify. Shifting economic conditions could vary in how they affect different parts of the bond market.
"Stay diversified, stick with low-cost funds. Expenses can really differentiate one fund from another," Berry said.
Berry notes diversification is important in case bonds showing strong performances fall out of favor.
"People in high-yield and in emerging-markets bonds should certainly be aware that we've enjoyed an incredibly long stretch of strong returns that could end at any time and could bring losses. The risks haven't been on display for quite a long time, and they could return at any time."
The Federated Total Return Bond Fund, with assets of about $1.8 billion and an annualized five-year return of 5.6 percent, invests in bonds ranging from Treasuries to investment-grade corporate bonds to high-yield bonds. Joseph Balestrino, senior portfolio manager and fixed-income strategist at Federated, contends possible shifts in the economy should make bond investors more cautious.
"This is not the time you want to reach for more income," he said. "We think the economy is slowing down. We believe that by the end of the year the economy will be at a slowing growth mode at best."
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