Bond Bulls Charge Into New Year

Move over equities. Here come the bonds.

Bond funds, which have played second-fiddle to stocks in recent years, are once again attracting investor dollars and posting tidy returns.

Much of the new money comes from foreign investors, who pumped a record $192 billion into fixed-income products in just the first half of 1997.

Experts expect bond funds will again enjoy a profitable ride in 1998, although turning in a slightly lower total return than in 1997.

"We are moderately bullish on bonds for 1998," says Michael Kennedy, who manages the Stein Roe Intermediate Bond Fund (800-338-2550.) The fund had a total return of about 9 percent last year. He expects a 7 percent return in 1998, perhaps a little higher.

Gains for bond prices will mainly "come in the second half of the year," assuming that the US economy slows, predicts David Blitzer, chief economist at Standard & Poor's Corp. in New York. He rates bonds a "hold" for now, until the economy's direction gets clearer.

New money

The public's new infatuation is evident in the money trail: Investors poured more than $13 billion into bond funds in 1997. That follows two years of net outflows exceeding $8 billion, according to the Investment Company Institute in Washington.

Factors shoring up bond values include a moderating US economy, low inflation, and volatility in equities markets. Mr. Blitzer expects the stock market to be especially volatile in 1998, which will make bonds look attractive to conservative investors.

And two somewhat unusual factors provide special help to bonds:

1. Shrinking deficits. With its budget shortfall declining, the federal government has not had to raise as much money as in prior years by issuing new bonds. The reduction in supply of new bonds pushes up the value of existing bond products.

Japan alone, according to investment house A.G. Edwards & Sons, is adding to its holdings of US Treasury securities at the rate of $5 billion to $6 billion a month. Japan already holds $321 billion in US Treasury issues as of Aug. 31.

2. Stock-fund managers looking for safety. If money managers shift additional dollars into bonds this year - as is expected - that will also help put upward pressure on bond prices.

In terms of total returns, high-yield (junk) bond funds led the pack last year, followed by long-term government bonds, long-term corporate bonds, and long-term municipal bonds, according to Chicago-based Morningstar.

Treasury securities outperformed most diversified US stock funds throughout the second half of the year. International bonds came in last.

Intermediate road?

A.G. Edwards, like many investment houses, expects long-term Treasury yields below 6 percent in 1998. Yields could drop to 5.5 to 5.75 percent, the St. Louis brokerage house says.

Any temporary rise in yields, to 6.4 percent or more, should be seen as a favorable buying opportunity, or a time to extend maturities, the firm advises in its new-year outlook.

For the really bullish, long-term bonds stand to gain most from falling rates.

But most investors should "stay short to intermediate," advises S&P's Blitzer. Durations of seven to 10 years are less volatile than 30-year issues.

He is wary of junk bonds, given turmoil in Asia and its potentially adverse impact on exporters.

Top bond funds of 1997 included three American Century-Benham funds (800-345-2021): the Target Maturity 2025, up about 31 percent; Target Maturity 2020, up 29 percent; and Target Maturity 2015, up 23 percent. These are for investors with specific time horizons.

Other winners: Summit High Yield (800-272-3442), up 18 percent, and Battery Park High Yield (800-254-2874), up 17 percent.

Rest Easier?

With stocks looking shaky, some experts advise boosting the bond side of your portfolio. Here's why:

* Other people are also buying bonds for safety. High demand means rising prices.

* With the federal deficit shrinking, the supply of government bonds is falling. That too, means higher bond prices.

* A slowing economy and low inflation may push down interest rates on new bonds. That adds luster to existing bonds.

But look out: If inflation perks up and interest rates rise, those existing bond prices will fall.