Bonds Funds Up, Equities Down in Q1

April 7, 2003 ( - Portfolios in high quality municipal bonds, high quality corporate bonds and high-yield bonds continued their winning ways in the first quarter of 2003, helping to offset losses in domestic and international equity mutual funds.

While even bond fund portfolios have been hurt by uncertainty in Iraq, the three categories have ended the quarter in positive territory.   The first quarter’s largest gains were seen in so-called “junk bonds,” returning 5.4% on average, as all 354 high yield bond funds tracked ended the period in the black (See  High-yield Funds Start Year 5.4% Higher ), according to data by Standard & Poor’s Fund Advisor.

“Junk bonds have been helped by low interest rates, which makes their yields look more attractive compared to other fixed-income investments, like Treasuries or money-market funds,” notes Joel Friedman, a director at S&P.

However, the 12-month rolling average default rate for domestic junk bonds stood at 6.9% on March 10th, down from 10.2% in April of 2002, according to S&P data.   “While the war in Iraq and the political tensions that preceded it have hurt stocks lately, their effect on the high-yield bond market has been virtually unnoticeable,” continues Friedman. “But, should interest rates begin to creep back up, the market could see some price pressure on a lot of the high flying high-yield bond funds.”

Likewise, pressure could be place on the other two bond categories in a rising interest rate environment.   Particularly, high-quality corporate bond funds, which gained 1.5% in the first quarter of 2003 on the heels of a three-year bull market for bonds.

Also watching the fed reports are high-quality municipal bond funds. These portfolios have benefited from a combination of a low-interest rate environment and the desire of local governments to launch new projects to stimulate their economies. The average high-quality municipal bond fund gained 0.7% in the first quarter of 2003.

Depressed Equities

The average domestic equity fund tracked by S&P was down 3.3% in the first quarter of 2003 with small-cap value funds taking the biggest hit, dropping 5.3%. Likewise uncertainty and anxiety over the war in Iraq have cast a black cloud over global markets causing most mutual funds that invest overseas to incur widespread losses in the first quarter. Through the end of March, the average international equity portfolio sank 7.6%.

Despite a handful of exceptions, stock markets around the world are in the red.   Particularly markets in Western Europe, which have historically followed United States markets downwards.   The major indices of Germany and France have each declined about 20% in the first quarter, while Britain’s FTSE index slid almost 10%.