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Stalled Yields Suggest More Risks

Savers discouraged by puny interest rates are often advised to crowd into short-term and ultra-short-term income funds. This is usually a riskless and profitable choice.

If you wrangle a 1.5% total return (net of fund expenses), you trounce today’s fixed-value offerings, including Treasury bills, online savings and one-year certificates of deposit (CDs). Clear 2% and you have serious bragging rights at happy hour, notes Jeffrey R. Kosnett, Kiplinger's Personal Finance.

But occasionally, these investments negate their higher payouts with principal losses, with the usual culprit a quick rise in the relevant interest rates. At worst, your principal value erodes while distributions decline as older, higher-paying investments mature. Investors are suffering this annoying situation in 2021. Dozens of ultra-short and short-term bond funds have negative total returns over the past three and six months, a pattern that might continue all year.

The mishaps stem from wild action in the “belly” of the yield curve, which means for maturities of up to five years. In April and June, the five-year Treasury yield approached 1% before easing back to 0.6% early in August; it settled at 0.83% on Aug. 13. This variance is tough on traders and fund managers. (Imagine the chaos in real estate if 30-year mortgages were to swing from 10% to 6% to 8% so quickly.) The two-year rate also went wild, leaping from 0.16% to 0.28% in just 10 days in June. That rate is now 0.23%.

These are fractions of a percentage point, but if you are chaperoning $50,000 or $100,000, it adds up. In February, Thornburg Limited Term Income (THIFX) closed at $14.02. By mid-August it’s $13.88, a 1% loss – and Thornburg Limited Term’s monthly payouts have also fallen steadily, from $0.0163 in February to $0.0141. The net asset value of FPA New Income Fund (FPNIX) is off just from $10.04 to $10.01, but FPA’s payout dropped from $0.0144 in January and $0.0128 in February to less than $0.010 in two of the past four months. These look like tiny numbers, but don’t be fooled. It often amounts to a 15% to 30% pay cut.

Thornburg, FPA and others in this boat, including BlackRock, Fidelity and Pimco, are excellent managers, and this isn’t to castigate their staffs for any reason. Only a handful of their competitors’ returns are above breakeven over the same period – usually thanks to luck. With a decade to invest, it’s preferable to invest in short and ultra-short funds to a series of CDs. But this year reminds everyone that angling for even more yield while keeping maturities short can be an effective buffer against unwelcome swings in principal value.

Editor’s Note: Jeffrey R. Kosnett is editor of Kiplinger’s Investing for Income newsletter,

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