The best ways to invest in bonds today

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Steven T. Goldberg

Long-term, high-quality bonds have had an incredible run.

Over the past 10 years, while stocks were going nowhere, the Vanguard Long-Term Treasury Bond fund returned an annualized 8 percent. Over the past three years, the fund returned an annualized 11 percent.

This year, through mid-October, the fund returned almost 20 percent. In fact, Treasuries have been on a tear since 1981 when yields on the ten-year bond peaked at 15.3 percent

But today the yield on the 10-year Treasury bond is below 2.5 percent. Common sense tells you that the yield doesn’t have much farther to fall. Bond yields move in the opposite direction from prices.

The biggest risk in bonds is that interest rates will rise and prices will fall as the Federal Reserve continues to print more dollars and the dollar falls in value against other currencies.

The way to earn profits in bonds is changing. Instead of buying long-term bonds that invest largely in U.S. government or high-quality U.S. corporate bonds, the better course is to look for bond funds employing other strategies.

Every investor needs to own bonds — for income and to provide ballast to a stock portfolio. Following are my best picks among no-load taxable funds for the coming months and year.

Bond funds to consider

DoubleLine Total Return (telephone 877-354-6311, symbol DLTNX) invests almost entirely in mortgage-backed securities. Manager Jeffrey Gundlach formerly ran TCW Total Return, steering it to an 8 percent annualized return over ten years before opening his own fund firm early this year with most of his old analysts.

About half the fund is invested in long-term, government-backed mortgage securities. The remainder is in riskier, high-yielding mortgages that should do well if inflation and interest rates surge.

The fund has returned more than 9 percent since inception in early April and has an annualized yield of more than 8 percent. Gundlach has proven adept at navigating poor markets, too. Expenses are 0.74 percent annually.

The foreclosure mess, in which banks failed to follow the rules in repossessing houses, shouldn’t create a big problem for DoubleLine.

The temporary moratorium on foreclosures by some banks may well stop or delay payments to the fund on some risky mortgages for several months. But the fund purchased these mortgages at 60 percent average discounts to their initial value, leaving plenty of leeway for holdups of this kind.

Pimco is probably the best bond fund shop in the U.S. But flagship Pimco Total Return now has assets of about $500 billion in the fund itself and in clones, such as Harbor Bond. Total Return is just too big to continue its long record of outperforming its peers.

Pimco Unconstrained Bond D (800-426-0107, PUBDX), managed by Chris Dialynas, is my pick to replace it. Dialynas, like Bill Gross, who manages Total Return, implements the strategies recommended by Pimco’s investment committee, of which they are both members.

But Unconstrained is bolder and, with assets of $12 billion, much more flexible. The fund can take any position the investment committee decides is appropriate, including making bets that bonds will rise in yield.

“Unconstrained isn’t married to an index,” Dialynas explained. It has returned 8 percent over the past 12 months and yields 2.6 percent. Annual expenses are 1.3 percent. 

Somewhat riskier funds

Another Pimco fund worth considering is Pimco Diversified Income D (PDVDX). It’s a multi-sector fund, meaning it invests in several different slices of the bond market. Manager Curtis Mewbourne currently deploys a big chunk of assets in emerging markets bonds.

The fund also owns corporate bonds in the U.S. and other developed nations, including some high-yielding “junk” corporate bonds.

Given the risky sectors this bond plays in, it’s a surprisingly conservative fund. Over the past three years it has returned 10 percent, and it yields 5.0 percent. Expenses are 1.15 percent annually.

For more foreign exposure, look at Fidelity New Markets Income (800-544-6666, FNMIX), which invests in bonds of fast-growing emerging markets.

While the U.S., Japan and much of Europe labor under the weight of huge budget deficits, most emerging markets nations are running fiscal and trade surpluses — and are growing rapidly.

What’s more, their bonds still boast much higher yields than you can get elsewhere. The fund has returned an annualized 11 percent over the past three years and yields 6.3 percent. Annual expenses are 0.90 percent.

How should you divvy up your bond money? The first two funds are relatively low risk, while the last two are fairly risky — especially the Fidelity fund. Many investors will do well to split their bond investment money evenly among all four.

Add a municipal bond in your taxable account (Baltimore-based T. Rowe Price offers excellent Maryland and Virginia tax-exempt funds), and you should fare well in a period where bonds, in general, may not.

Steven T. Goldberg is a freelance writer and investment advisor in Silver Spring, Md. He welcomes reader ques­tions. E-mail or write to Steven Goldberg, 9005 Woodland Dr., Silver Spring, MD 20910. You may also call him at (301) 650-6567.