The bond funds

When the hare slows down, put your money on the tortoise

The economic news is good — retail sales are up, unemployment is lower, corporate profits are strong. Yet, as the graph overleaf shows, the stock market has derived little inspiration from all of this, and analysts are returning to basics in search of good stocks to recommend. Sample: new strength will come not from traditional glamour stocks but from moderate growth stocks — “forgotten stocks” like General Telephone & Electronics or McGraw-Edison, says Manown Kisor, head of research for Paine, Webber, Jackson & Curtis.

In this dull atmosphere, corporate bonds and mutual funds that invest heavily in bonds — the so-called “income funds” — take on a certain luster as intermediate-term investments. A high-quality 30-year utility bond will pay between 7.50% and 7.75% in interest. Not bad, considering there is virtually no risk. After all, common stocks with much less security yielded only an average 9% a year between 1926 and 1960, according to a University of Chicago study.

If an investor is willing to settle for a slightly lower quality bond, he can clip coupons worth 8% a year or more. Merrill Lynch thinks that bonds rated Baa by Moody’s Investors Service and BBB by Standard & Poor’s are sufficiently safe for most investors.

Even within that category there are often interesting differences. For example, a Hart Schaffner & Marx Baa bond has been yielding about 8.20%. A U.S. Plywood-Champion Papers bond with the same rating has been yielding about 7.80%. Merrill Lynch’s vice president in charge of bond research, Shirley Alexander, attributes the difference mostly to technical factors. Both issues were offered in units of $1,000, though at different times. The clothing chain’s bonds had an initial yield of 8.50%, which comes to $85 per bond, compared with 8%, or $80, for the U.S. Plywood issue. The price of the Hart Schaffner bonds has since risen, making the $85 equivalent to only an 8.20% return. The Plywood issue has behaved similarly: its price has also climbed, lowering its yield to 7.80%.

The prices of bonds can be just as interesting as their interest rates. The bond market works on the same auction principle as the stock market, and bond prices can fluctuate according to the condition of the company behind them. The most desirable bonds are those of an ailing company on the way to recovery; yields should be high and the price well below the $1,000 par value, though climbing. One analyst believes that some rail bonds now selling in the 400s are prime candidates for such a turnaround (B&O convertible bonds, for example).

The ideal price situation is one in which a company’s improvement is so solid that the quality rating of its bonds is about to be upgraded by Moody’s or Standard & Poor’s. Patrick P. McKevitt, bond analyst for Bache & Co., thinks that some western and southwestern utilities are ripe for an upgrading.

Such analysis is not readily available to the individual investor, and there are other factors that make bond trading a bit tricky. Compared with the stock market, the bond market lacks depth; buyers are sometimes so scarce that an investor cannot sell when he wants to. What’s more, since most bonds are issued in large dollar amounts ($5,000 is the usual minimum), investors have little opportunity to diversify. “Bonds are a professional commodity,” says Michael Lipper of New York’s Arthur Lipper Corp., the mutual fund analysts.

For these reasons, the income funds are especially appealing. Since the income fund investor owns shares of a mutual fund rather than actual bonds, he can get in and out of the market with relative ease. In addition, although the funds generally charge high sales commissions (starting at 8.5% for small purchases), they provide a sizable yield. Those without sales commissions, the “no-load” funds, generally aim for growth rather than income. Assuming dividends are reinvested, Arthur Lipper Corp, reckons that income funds have fared almost as well over the past five years as their more aggressive competitors, the growth funds. And, to repeat, usually with less risk.

There are currently about 70 income funds on the Lipper list; nine of them are new this year. Within the 70, there is a wide assortment of sizes and strategies. A few, like the tiny BLC Income Fund of Des Moines, shy away from bonds and stick to high-yield stocks. At the other extreme are funds that invest almost entirely in bonds — the $100 million Lord Abbett Bond-Debenture Fund, for example, or three separate funds managed by Keystone Custodian Funds of Boston. Many income funds, however, divide their portfolios about equally between bonds and stocks.

Strategy is just as important to the income fund investor as balance. The $200 million Keystone B-4, which has grown about 17% in the past year and over 40% in the five and a half years ending last June, is an aggressive bond fund that looks for ailing companies on the mend. Leonard Darling, the fund’s manager, recalls one particularly sweet success. In the  spring of 1971, he bought some $3 million worth of bonds of Whittaker Corp., a West Coast conglomerate. The bonds were priced in the high 800s, but the company’s prospects improved handsomely, and the bonds are currently trading at about $1,050. The new Oppenheimer Income Fund will be even more aggressive. Manager Thomas A. Sullivan says he may turn over 100% of his portfolio every year.

All of these funds are open-ended: investors can buy in or sell out more or less at will, the value of the shares rising and falling with the prices of the securities in the portfolio. From time to time, closed-end funds go on the market with offerings of tax-free municipals or corporate bonds. Bache is one of the leaders in the municipal field, having participated in the sale of over $1 billion worth of closed-end funds in the past eleven years. Merrill Lynch, probably the largest seller of bonds to individual investors, has just come out with a closed-end corporate bond fund. Closed-end bond funds, usually designed to assure a safe and steady income to the investor, offer professional management up front, but little flexibility; once a portfolio is selected, it generally stays selected; when it is fully subscribed the books are closed. No one else can buy in unless an investor is willing to sell.

Flexibility, just now, may prove very valuable. Henry Kaufman, an economist for Salomon Brothers, feels that the recent spurt in short-term interest rates, plus increased short-term borrowing by the U.S. Treasury, plus the Federal Reserve’s tighter monetary policy will all combine to prod long-term interest rates higher. Accelerating inflation would also boost rates. He figures that yields from high-grade utility bonds, for instance, will move into the 8%-to-8.5% range during the next twelve months, so it might be better for the investor to wait awhile before he buys bonds. Income funds have the flexibility to do just that. Felix Smith, who runs the $140 million Putnam Income Fund, hopes to take advantage of the higher bond rates to come by putting some of his money into cash and short-term debt securities for the time being.

Other analysts, however, believe the rise in long-term rates will be too small to be of any consequence to the individual investor. Some find reasons to be bullish about bond prices right now. Foremost among these are economists who view late 1973 and early 1974 with foreboding. They feel that a combination of slimmer profit margins, less exuberant consumer demand, negotiation of labor contracts and a post-election crackdown on prices and crank-up of taxation could put a damper on the economy. Long-term interest rates, they figure, might even drop — but since they are inversely tied to bond prices, bond prices would then generally rise. Although he believes long-term rates will go up, Kaufman concedes that either way you look at it, “if you take the long view, bonds might very well be an attractive investment, now.” — J.G.M.