For growth with stability, the game is bonds

Welcome to the 21st century: Bonds - wallflower investment products during much of the stock-market-oriented 1990s - are back.

And for now, at least, they are outperforming stocks.

A number of bond products - including US government-inflation-indexed securities - also provide returns well ahead of recent upticks in inflation.

"While stocks will do well this year, they are not going to give us 20 percent or more returns like the past few years," says Tim Schlindwein, a mutual-fund consultant in Chicago. "That means ... bonds will look more attractive to many investors."

"We see very little risk for bonds right now," says Arnold Kaufman, editor of The Outlook, a financial review published by Standard & Poor's. "Changes in price and yield seem modest," says Mr. Kaufman. "If you want to increase your income [cash flow], then it might be best to buy into the bond market gradually now, with rates rising.

"Two-year Treasury notes look especially promising, yielding about 6.3 percent," he adds.

Through June 19, the Merrill Lynch Domestic Master Bond index was up 3.87 percent for the year, compared with a miniscule gain of 1.14 percent for the Standard & Poor's 500 (stock) index, and a loss of 8.17 percent for the blue-chip Dow Jones Industrial Average. (The Merrill Lynch index includes most US investment-grade bonds.

Indeed, almost all key bond indexes now show positive - and in some cases, hefty - gains. The only exception within the bond universe is the high-yield (junk) bond sector, where total returns are in negative territory.

Issuance of junk bonds is down sharply, according to Moody's Investors Service. Companies that issue high-yield bonds often have difficulty meeting interest payments. Moreover, investors become wary of buying such risky products in a slowing economy.

The upshot: Fewer new junk-bond offerings come to market in a slowing economy, as is now occurring.

But if junk is in trouble as a category, that cannot be said for other major bond products, such as intermediate bonds in the two-year range, 10-year issues, and long bonds. Tax-exempt municipal-bond products and mortgage-backed government securities are also posting solid returns.

According to information firm Lipper Inc., yields on general bond mutual funds are now more than 6 percent. As yields have risen, bond prices, which move inversely to interest rates, have fallen. But prices are expected to stabilize during the months ahead, as the Fed eases up on tightening, Kaufman says.

One sector that might benefit from the renaissance in bonds is the little known "socially responsible" bond category. Several socially responsible mutual fund groups offer fixed-income products, including Parnassus, Citizens, and Calvert.

They were joined recently by the Domini group, which has created the Domini Social Bond Fund. "We wanted to give our subscribers a bond product that would do something other than just make good returns," says Amy Domini, founder of the Domini group. The new fund, which has just under $3 million in assets, is linked with the South Shore Bank in Chicago, the nation's largest community-development bank.

The Domini Social Bond Fund uses a special screening process to invest in socially responsible government and corporate debt issues, with most maturities ranging from two to five years. The fund will make monies available for affordable housing and small-business development.

The upbeat gains in bond products - both individual bond issues and for bond mutual funds - may be somewhat shocking to many of today's investors, especially among the huge boomer population, who have equated financial markets primarily with stock markets.

Bonds have lagged behind stocks throughout most of the 20th century. Indeed, bonds have rarely edged out stocks since the mid-1920s, according to financial services firm Ibbotson Associates, in Chicago. The best periods for bonds occurred during the depression years of the 1930s, and then again in the 1960s and '70s.

Investors should have at least 25 percent of their portfolios in bond products, says Kaufman. Such diversification is especially important in a turbulent economic climate, he says.

Bond products, he and others stress, are not so much geared toward gaining high return as toward protecting assets against sharp losses.

Given the complexity of fixed-income instruments, investors who are not familiar with bonds "should definitely use a bond mutual fund," says James Fraser, president of Fraser Management Associates, in Burlington, Vt.

"Buy your bond products from a well-established mutual-fund company that has wide experience in bonds," he says. Or, if you prefer, use a well-established brokerage house that deals in fixed-income products.

One bond product that has gone largely ignored by the general public seems especially relevant in the current economic setting: TIPS, or US Treasury inflation-protected securities.

TIPS provide both a guaranteed interest rate, plus an adjustment for rising inflation. Two large mutual-fund companies, PIMCO and Vanguard, offer TIPS funds.

(c) Copyright 2000. The Christian Science Publishing Society