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Rising Rates Haven't Hurt these Bond Mutual Funds

Zacks Equity Research

In September 2010, the National Bureau of Economic Research said the U.S. economy had exited a painful recessionary period in June 2009. This was the official confirmation that the worst was over, following the sharpest downturn in more than fifty years.

The number of jobs lost in this period was in excess of eight million. The major factor responsible for this decline was a series of questionable investments related to mortgages. The subprime mortgage crisis led to a financial crisis of enormous proportions, typified by the fall one of Wall Street’s biggest names, Lehman Brothers.    

Federal Reserve Action

The Federal Reserve responded to the situation by implementing monetary easing measures of unprecedented proportions. Initially it lowered the Federal funds target rate from 5.25% to 2%. The discount rate was lowered to 2.25% from 5.75%. Ultimately, in December 2008, the Fed pushed down the rate within a range of 0 to 0.25% or 25 basis points.

The Fed also decided to significantly expand the size of its balance sheet around the same time. In November 2008, the central bank launched a $600 billion program to purchase mortgage backed securities of housing-related government-sponsored enterprises. In March 2009, it said it would purchase an additional $750 billion of mortgage backed securities. It also made large purchases of long term Treasury securities and agency debt that year.

A Change in Direction

With the economic recovery remaining slow until recently, the Fed has continued with its policy of keeping interest rates at historically low levels through open market operations. As of now, the Fed purchases Treasury and mortgage backed securities worth $85 billion every month. It intends to keep short term interest rates at historically low levels until unemployment declines below 6.5% and inflation rises to 2.5%.

However, in May Fed Chairman Ben Bernanke said the central bank would begin to reduce the quantum of its purchases gradually. He added that quantitative easing would end altogether by 2014. This resulted in interest rates moving upwards. Last week, the figure touched the 3% mark, the first time such a level was achieved since 2011.

The Fed is widely expected to reduce the level of Treasury purchases from $45 billion a month to $35 billion a month. The rise in interest rates has already impacted bonds. However, some bond funds have managed to ride the storm, even gaining over the last month. We are providing you with three such choices which have bucked the trend.

Mutual Fund Picks

Putnam Short Duration Income A (PSDTX)

Launched in October 2011, this is a large fund with net assets of $1.25 billion. The fund purchases a wide range of fixed income instruments. These include money market securities and other fixed income investments, rated investment grade. The fund is up 3.21% over the last month.

The mutual fund holds 589 securities in all. Its top 10 holdings make up 6.74% of its assets. Its top 3 holdings are Svenska Handelsbanken Ab FRN, Wachovia Corp New FRN and Bk New York Mtn Bk Ent FRN. The fund returned 3.77% over the last one year period and has a Zacks Rank #1(Strong Buy).

American Funds Tax-Exempt Maryland A (TMMDX)

The oldest of our choices, the fund was launched in August 1986. The net assets of the fund are in excess of $348 million. The fund focusses on investing in securities, returns from which are not subject to regular federal as well as Maryland income taxes. They must also be exempt from federal alternative minimum tax. The fund is up 3.36% over the last month.

The fund has a total number of 216 assets. The asset it is most invested in is Maryland St Health & Higher Ed Var Rev B, which makes up 3.48% of its assets. The next two, Montgomery Cnty Md Hsg Oppntys Rev Bd 4% and Maryland St Health & Higher Ed Rev Bd 5%, together make up 2.34% of its assets. The fund has a Zacks Rank #1(Strong Buy).

Delaware High-Yield Opportunities A (DHOAX)

This is a fund with a minimum initial investment requirement of $1,000 and was launched in December 1996. This fund focusses on investing in high yield bonds, which are rated BBB- or lower. A maximum of 25 of its assets are invested in foreign securities. The fund is up 3.20% over the last month.
This fund holds a total of 269 securities. Its top 10 holdings account for 8.632% of its assets. Its top three assets are Hbos Cap Fdg No 2 L P 144A FRN, Univision Comms 144A 8.5% and Ing Groep N V FRN. The fund returned 12.06% over the last one year period and has a Zacks Rank #1(Strong Buy).
With interest rates slated to rise further, bond investors may have tough times ahead. But even in such an environment, these mutual funds have continued to register gains, making them good additions for your portfolio.
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