A lot of people have a lot of money in banks and money market funds earning nothing. Even worse, their cash is slowly losing ground to inflation. I think I've found a good place to stash some of that money: FPA New Income (symbol FPNIX). The fund yields 2.6%, not bad in today's environment. But it's certainly not a no-risk proposition.
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For starters, New Income isn't federally insured. And the fund's price changes every day based on the market prices of its holdings. But since FPA took over management of New Income in 1984, the fund has never lost money in a calendar year. So far in 2013, the fund has returned 0.19% (all returns are through June 25).
That doesn't mean the fund never loses money. Since FPA took over management of the fund in 1984, New Income's worst monthly loss was 2.3%, in 1985, and its worst quarterly loss was 3.0%, in the third quarter of 2003. Since 1984, the fund has finished in the red in 15% of all months and 7% of all quarters. So New Income carries some risk of loss, but the risk is limited enough to make this fund a solid substitute for cash for some investors.
The primary goal of the fund's managers is to avoid losses over any 12-month period. Their secondary goal is to return, over a five-to-ten-year period, one percentage point more per year than the increase in the consumer price index. "We put a huge focus on capital preservation," says co-manager Tom Atteberry. That focus only sharpened after the 2008 financial meltdown.
Atteberry, who has co-managed the $5 billion fund since 2004, and colleague Robert Rodriguez think bonds are wildly overpriced. Over the past month and a half, some of the air has come out of the bond bubble. From May 2 through June 25 the yield on the benchmark ten-year Treasury bond soared from 1.62% to 2.61%. Because bond prices move in the opposite direction of bond yields, most bond funds experienced significant losses during that period. (FPA New Income lost 0.8% during that period.) But the correction in bond prices still has a way to go, in my opinion.
Consider a few numbers. Since 1962, the ten-year Treasury bond has yielded 6.3%, on average. The one-year Treasury bill currently yields 0.16%. Its average yield since 1953 has been 5.0%. High-yielding "junk" bonds currently yield about 6.9%. The average yield has been more than 10%.
Atteberry, Rodriguez and three analysts assemble their portfolio with extreme care. To start with, they don't buy long-term bonds. If yields on bonds similar to the ones in New Income were to rise by one percentage point, the fund would probably fall just 1.6% in price. But you'd still collect interest, and over time those payments would rise as the managers reinvested maturing bonds in higher-yielding issues.
The fund is an interesting stew of bonds with two common factors: They're all fairly low risk, and they all have solid collateral behind them. "We're belt-and-suspenders investors," says Atteberry.
Government-backed mortgage securities from Fannie Mae and Freddie Mac account for 44% of assets. The managers carefully study the loans with an eye toward making sure they will never need that government backing. Another 16% of assets are in commercial mortgage-backed securities that are backed by Uncle Sam.
The fund does have a chunk of assets in nongovernment-backed loans. For instance, 5% of the fund is in private commercial mortgage-backed securities. The borrowers, however, are luxury resort hotels in good locations that seem highly likely to pay off their debts, such as the Royal Hawaiian on Waikiki Beach.
The fund also owns some securitized used-car loans. Atteberry says the company that originally financed the loans has agreed to take the first 15% in losses if car buyers default on their loans. What's more, he says, "People pay on their cars before they pay on their houses or their credit cards." And if they don't, the cars can usually be sold for enough to pay off holders of the securities.
What could go wrong? The fund, in theory, is virtually impervious to rising interest rates. But that low interest-rate sensitivity will be tested if rates spike sharply. Similarly, the average credit quality of the fund's holdings is triple-B, which is near the bottom of the investment-grade ladder. If the economy slips into recession, the sturdiness of New Income's bonds will be tested.
For many years, New Income charged a sales fee. The fund converted to no-load status on April 1. Expenses, at 0.57% annually, are reasonable. But note that New Income levies a 2% redemption fee if you take your money out within 90 days of purchase. There's no such thing as a no-risk bond fund. But New Income is a low-risk fund. I don't think you'll find another fund that yields as much and carries less risk.
Don't expect to get rich owning New Income. Over the past five years, the fund returned an annualized 2.7% &mdash: about half the return of the Barclay's U.S. Aggregate Bond index. In the coming year or two, I expect the fund's annual return to be even less, perhaps 2.5%.
But 2.5% is better than what you earn nowadays in money market funds and almost all bank accounts. I think the risks are small enough to make New Income a fine alternative.Steven T. Goldberg is an investment adviser in the Washington, D.C. area.
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