NEW YORK — Don’t expect much from your bond mutual fund next year.
The bond market likely will produce modest returns, if they’re positive at all, according to many bond-fund managers. It’s a matter of math: Bonds are offering very low interest rates following a decades-long drop in yields. That means they’re producing less income.
It also means bonds have less protection from rising interest rates. When rates climb, the price for existing bonds falls because their yields suddenly look less attractive than those of newly issued bonds. If bonds were yielding 8 percent or 10 percent, they could more easily make up for a decline in price with their interest payments. But a 10-year Treasury note offers a yield of just 2.24 percent. Less income means it takes a smaller price decline to saddle bond investors with losses.
“We’re getting to the point where it’s really dangerous,” says Bill Eigen, manager of the JPMorgan Strategic Income Opportunities Fund. He says he’s the most nervous about the prospect of rising rates that he’s been in his career.
Investors got a taste of what bond losses felt like last year, when the average intermediate-term bond fund fell 1.4 percent due to a rise in rates. It was the biggest loss for the bond market in nearly two decades. Managers say it’s best to prepare for big swings in bond returns next year.
Many managers predicted bond losses a year ago, and they were wrong. Interest rates unexpectedly fell, and this year the average intermediate-term bond fund has returned about 5 percent.
But even the more optimistic bond fund managers say returns likely will be lower in 2015. Virtually all economists expect the Federal Reserve System to raise short-term interest rates in 2015, which would be the first increase since 2006. The central bank already ended its bond-buying stimulus program, shuttering it in October.
“Given where bonds are, you should not be thinking about a return like this year,” says Matt Freund, chief investment officer of USAA mutual funds. “It could happen, but I wouldn’t want to base my financial plan on it.”
Even though the economy is improving, it’s still fragile. That could lead the Fed to move more slowly in raising interest rates than many investors expect, Freund said.
Inflation also remains low, with the price of oil close to a four-year low and the dollar at its strongest level in years. That gives the Fed more leeway to take its time in raising rates.
Long-term bonds lock investors into yields for a longer time period, so rate increases can hurt them more than short-term bonds. That’s pushed many investors to pile into short-term funds, hoping to reduce their risk.
The $22 billion that they put into short-term bond funds during the past year is 10 times what they put into intermediate- and long-term bond funds, combined, according to Morningstar Inc.
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