Some Bond Funds Not What They Appear

The number of bond funds that own stocks has increased dramatically – and could be yet another sign of investors’ willingness to take on bigger risks in order to boost their returns.

A May 1 article by the Wall Street Journal reports on how more bond funds are shifting their assets into stocks and how such a strategy could result in unexpected losses for many investors.

More bond mutual funds now own at least some stock, according to Morningstar, Inc. Some 352 mutual funds that are classified by Morningstar as “bond funds” held stocks as of their last reporting date. That’s up from 312 at the end of 2012 and 283 in the first quarter of 2012.

As the WSJ article points out, “the jump into stocks illustrates the dilemma bond investors face. The bond market has rallied for much of the last 30 years, and yields, which move in the opposite direction of prices, stand near record lows.”

The Securities and Exchange Commission (SEC) generally requires bond and income funds to invest at least 80% of their assets in the type of assets suggested by their names. But, says the Wall Street Journal story, certain words with vague meaning like “value” or “income,” don’t trigger the requirement. Funds must also stick to any requirements that managers outline in the prospectus.

As a result, investors in some bond funds could be surprised by large stock exposure. Almost all of the 352 funds investing in stocks call themselves income or bond funds.

The article cites the example of the $15.4 billion Loomis Sayles Strategic Income fund. Since mid-2011, the fund has increased its stock and preferred-stock allocation from 5% to more than 19%.

Some financial advisers aren’t on board with that strategy, expressing concern that the increased stock allocation could easily make the bond fund more volatile and move more in tandem with stock indexes.

Accredited Investors Inc., an Edina, Minn., registered investment adviser with $1.2 billion under management, last year cut its allocation to the Loomis Sayles Bond Fund by a third after finding out that the fund had started to buy stocks.

“We’re completely sympathetic to arguments regarding yield and rising interest rates, but you can’t be making decisions by yield alone,” said Accredited investment manager Jacob Wolkowiz in the Wall Street Journal.