Investors have been moving out of money-market funds into short-term bond funds, and while short-term bond funds are considered to be relatively safe, beware, says Tom Lauricella in his recent article in the Wall Street Journal, “Short-Term Bonds May Disappoint Investors This Year.”
The near-certainty of rising interest rates poses a huge risk to the net asset value of all bond funds, including short term funds, all of which have had a big run-up, and are, perhaps, poised to fall. Bond prices move in the opposite direction from interest rates. Interest rates for safe investments (treasury bonds, money market funds, certificates of deposit) are almost zero. When interest rates climb, bond prices and bond fund NAVs will fall ? probably sharply if the Federal Reserve raises interest rates aggressively.
In addition, bond funds that are called “short-term” may not be, and may hold concentrations risky securities that can fall more than the average short-term bond fund. We recently saw that a bond fund, promoted as an “ultra short term” bond fund that was like a money market fund, was actually a bet on mortgage-backed securities and dropped over 30%.
Even money-market funds don’t guarantee against losing money, as we saw when the collapse of Lehman Brothers Holdings Inc. caused Reserve Primary Fund to melt down.
On the other hand, bond yields (and bond fund yields) will go up. So if you are a buy-and-hold bond fund investor, your income will increase as fund managers reinvest at higher rates. If you do not need to sell shares of the bond fund, then you should not be overly concerned about a lower NAV.
“The good news is that even in the worst rising-rate environment, outsized losses have been rare” in short-term bond funds, says Eric Jacobson, director of bond-fund research for Morningstar. Still, “people should be very well prepared for losses.”
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