Strong Views Serve Federated Bond Fund Well
.
By Michael A. Pollock
Of DOW JONES NEWSWIRES
NEW YORK (Dow Jones)--Some fund managers don't even try to read the economic tea leaves because they believe no one can anticipate interest-rate and market trends.
But the $1 billion Federated Bond Fund, which buys corporate bonds to generate income, thinks it doesn't have much choice. Its performance hinges on its ability to adeptly shift around on the corporate-credit ladder, as well as on the yield curve or the bond-maturity spectrum.
Based on the firm's views, lead manager Joseph Balestrino of Federated Investors Inc. (FII), gradually has been shifting toward interest-rate sensitive issues and trimming economically sensitive bonds, among other things.
That's based on expectations that U.S. rates are near their peak for this cycle and will start to fall as economic growth and business conditions weaken in the second half.
"We think that as painful as it may be over the near term, it will pay shareholders to seek less yield - which means higher quality - and to go out a little longer out the (yield) curve," he adds.
Federated, Pittsburgh, was among the firms involved earlier this decade in the market-timing scandal, which saw rapid buying and selling of mutual-fund shares in violation of fund policies. That history, along with the Federated Fund's 1.08% expense ratio, which is above average, and somewhat larger-than-typical high-yield holdings, led Morningstar Inc. (MORN) to tell investors in a recent analysis to steer clear of the fund - although Morningstar gives the fund a relatively high four-star rating.
Despite its conclusion, Morningstar's write-up was heavily positive, Balestrino says.
Certainly, the fund's performance has been strong. On both a three- and five-year annualized basis, its returns have ranked in the top 3% of its category. The year so far has been tough for bonds in general, but Federated is currently ranked in the top 5% with a 0.2% total return - 0.8 percentage point ahead of the benchmark Lehman Brothers Aggregate Index, which is down 0.6% year to date.
Assets in the fund, however, have declined by about 10% from a year ago amid a small drop in net-asset value and modest outflows. Balestrino acknowledges that with the likelihood of the economy weakening, investors may be cautious toward corporate bonds.
"Obviously, there are good and bad aspects to the corporate bond market," he says. "We hope that an investor can look simply at our numbers and say, 'They seem to have done a pretty good job accessing the high-yield market and reducing it at the appropriate times.' That's the key."
Although securities selection is important to any corporate bond fund, there were three primary drivers in the fund's performance during the past year, Balestrino says.
One was a "barbell" position, a wager on convergence between short- and longer-term yields. In addition, the fund also maintained a slightly shorter duration - or sensitivity to interest-rate moves - at below five years.
The third driver was a wager on high-yield bonds. By prospectus, the fund must have at least 65% of its portfolio in investment-grade securities. But in 2005, while many people fled the high-yield sector, Federated maintained an overweight there. The wager paid off nicely as high-yield outperformed most other sectors.
More recently, Federated slowly has been trimming its high-yield allocation, which is down about 10 percentage points from a year ago. It also is making other moves in preparation for what it sees as an evolving economy.
The fund has been reducing exposure to economically cyclical industrial issues, such as auto suppliers, chemical companies and paper companies. One exception is metals and mining, where Balestrino sees ongoing strength.
The fund also has tilted toward financial companies, including banks.
According to Morningstar, an example of a financial issue the fund acquired recently is HSBC Finance Capital Trust notes due 2035, which was among Federated's 25 largest holdings. And reflecting Balestrino's liking for resource issues, the fund also recently had debt of Barrick Gold Corp. (ABX) among its biggest 25 holdings.
While it has moved up the credit ladder, Federated tries to avoid issues that seem vulnerable to a leveraged buyout or any other event that might cause ratings and bond prices to plummet. It screens for companies that have a lot of cash and whose share prices have languished.
"Any way that the cash gets to the shareholder probably is unfriendly to bondholders," Balestrino says.
(Michael A. Pollock, a special writer at Dow Jones Newswires, covers global fixed-income investment topics.)
-By Michael A. Pollock, Dow Jones Newswires; 201-938-2004; michael.pollock@dowjones.com
(END) Dow Jones Newswires
April 24, 2006 15:00 ET (19:00 GMT)
Copyright (c) 2006 Dow Jones & Company, Inc.- - 03 00 PM EDT 04-24-06 |
