Index funds showed the strongest returns among commingled bond managers in the second quarter, with three funds run by Barclays Global Investors taking the top spots in the Pensions & Investments' Performance Evaluation Report.
The same three funds also turned in the strongest performance for the 12 months ended June 30. Their returns far surpassed the Salomon Broad bond index, which had a 2.3% return for the quarter and a 10.6% return for the year, and the Lehman Brothers Government Corporate bond index, which had a 2.6% return for the quarter and an 11.3% return for the year.
They also far surpassed the median PIPER commingled fixed-income fund, which returned 2.2% for the quarter and 10.2% for the year, underperforming the Salomon and Lehman benchmarks.
Barclays' 20+ Treasury Bond Index fund had a 5.17% return for the quarter and a 21.52% return for the year. Its Long Government Bond Index fund had a 4.68% return for the quarter and a 19.71% return for the year, and its Long Corporate Bond Index fund had a 3.55% return for the quarter and a 15.33% return for the year.
Falling interest rates have been a major force behind the success of the Barclays funds, according to Prabhu Palani, a relationship manager at San Francisco-based Barclays. "We have very high duration bonds in these funds, of 10 years or more. Falling interest rates tend to help funds with such high duration," he said.
The nervousness about emerging markets, including Asia, and about the U.S. equities markets also have caused a "flight to quality," said Mr. Palani, which helped boost the returns of the $3.7 billion 20+ Treasury Bond Index fund and the $3.6 billion Long Government Bond Index fund. The strong economy, falling interest rates and the narrowing of spreads on corporate bonds were of particular help to the Long Corporate Bond Index fund, which has $2.9 billion, he added.
While acknowledging it's "hard to predict the future," Mr. Palani said the strong dollar, continuing concerns about emerging markets and a mild slowdown in the U.S. economy all point toward a continuing decline in interest rates, which should help the bond market.
For the three-year period ended June 30, the median PIPER fixed-income manager reported a compound annualized 7.7% return, while both the Salomon and Lehman indexes reported a 7.9% return.
Ronald F. Stajkowski, president of Beverly Trust Co., Oak Lawn, Ill., which was acquired during the quarter by St. Paul Federal Bank, Chicago, and was renamed St. Paul Trust, said his firm's bond fund is managed with the continuing adjustment of his interest rate forecast. The approximately $200 million fund placed fifth among commingled funds for the quarter, with a 2.95% return, and fourth for the year, with 14.9%. "At the beginning of the year I knew the Asian crisis would cause deflation," he said. "Most portfolio managers thought the Asian crisis was a one-quarter problem, but I see it as a five- to 10-year problem.
"As a portfolio manager I want to be out as far as I can get on the yield curve," he said. "I want to lock in yields we won't see again for years." He expects interest rates will continue to fall, predicting the interest rate on the 30-year Treasury bond will fall below 5% in 1999.
Transamerica Investment Services, Los Angeles, also did well in the rankings. Its $605 million bond fund placed sixth among commingled bond funds for the year, with a 12.99% return, and ninth for the three years, with an annualized 9.53% return.
"The fund focuses on credit research and those industry sectors and companies we think will do well over the long term," said Susan Silbert, portfolio manager. She added that the fund holds its investments for a long time -- about a 12- to 24-month period -- when it likes a company and its management.
In essence, Transamerica invests in "undervalued" companies, whose debt is trading at too high a yield for their sector and rating. "We'll buy a bond rated BBB and hold it until it gets upgraded to an A rating, when the price rises," she explained.
About 16% of the fund is invested in electric utilities, which were strong performers in the first quarter and continued their good performance in the second quarter. "If corporate bond spreads widen, we expect utilities will widen less," said Ms. Silbert.
Texas Commerce Bank, Austin, Texas, which recently changed its name to Chase Bank of Texas, had its bond fund place seventh for the quarter among commingled funds, with a 2.87% return, and ninth for the year, with a return of 11.85%.
"We have a long historical policy of adhering to a high-grade orientation in our investments," said portfolio manager John Miller. When the Asian crisis hit, the fund reduced its holdings of corporate bonds and increased its Treasury bond investments. At its most recent statement date, the $78 million fund had 79% of its assets in Treasury bonds.
Mr. Miller said that with the federal government balancing its budget and now showing a surplus, "The Treasury issued a lot less bonds over the last year, because it needed less money. This dramatically reduced the supply of Treasury bonds, and helped boost their price."
The bank also carefully tracks the inflation outlook. Because of the low inflation forecast, the fund has extended the duration of bonds in its portfolio. "Approximately 60% of our portfolio is in long-term, 30-year bonds, most of which are Treasury bonds," said Mr. Miller.
Wilton, Conn.-based Bridgewater Associates' Extra Long Duration Bond fund reported the strongest return, 11.19%, for managed bond funds in the second quarter. The median PIPER managed fixed-income bond portfolio reported a 2.1% return for the quarter.
The approximately $300 million Bridgewater fund also ranked first in performance for managed accounts for the one-, three- and five-year periods, with returns of 48.56%, 33.43% and 17.29%, respectively. (Returns for more than one year are annualized.)
"We're in an interest rate environment where longer-duration bonds performed well in the second quarter," said Niall Ferguson, a marketing associate for the firm. "The fund has long-duration, high-sensitivity bond exposure."
Bridgewater's Extra Long Duration portfolio has a benchmark equivalent of a 25-year duration portfolio of Treasury bonds. "We have the leeway to change the duration and make it longer, which is what we did in the second quarter," said Dan Bernstein, director of research. "With interest rates falling, we've been extending the duration even further. Now it's close to 30 years."
The fund has positions in both U.S. corporates and Treasuries as well as foreign bonds. "We have a positive outlook for Europe," Mr. Bernstein said.
The $3.3 billion fixed-income composite of Hoisington Investment Management, Austin, Texas, came in second among managed bond funds for both the quarter, with a 6.11% return, and for the year, with 26.16%.
"Inflation is the main variable we monitor," said Lacy Hunt, executive vice president. "When inflation is going down we invest in Treasury bonds. When we see it going up on a multiyear basis, we invest in Treasury bills," he added. The fund only invests in Treasury securities.
"We now see the possibility of deflation," said Mr. Hunt. "We're also holding long-dated, zero-coupon Treasury bonds. They've performed even better than our cash bonds."