Bond Funds Shed the Blues

Bond-fund managers gaze at low inflation and high stock prices, and they like what they see.

"Bonds are most attractive relative to stocks," says Daniel Fuss, who manages one of the nation's leading bond mutual funds, Loomis Sayles Bond Fund (800-633-3330) in Boston, up 14.5 percent through Oct. 7.

Some investors agree. In the third quarter, government bond funds enjoyed the first net inflows of cash since 1993.

In part, it's a quest for safety amid sky-high equity markets. Even Mr. Fuss concedes that bonds are boring.

"I belong to the fuddy-duddy investment club," he jokes. "It is a nice quiet peaceful business. You sit back and listen to the interest compound."

But he and other bond experts see big gains to be made. Interest rates on new bonds will fall, they predict, pushing up the price of existing bonds.

That's partly because of low inflation. Real interest rates - nominal rates, the ones you read about, minus the inflation rates - are high by historical standards.

The benchmark 30-year Treasury bond now yields about 6.24 percent, and Fuss sees it falling "near 5 percent" next year. If he's right, long-term bonds would rise about 20 percent in value.

And while he suspects the Federal Reserve will raise short-term rates by early winter, he sees the long-bond rates holding fairly steady.

William Gross, who manages the world's largest collection of bond funds (PIMCO Total Return Fund: 800-927-4648), also sees long-term rates falling, ending this year at about 6 percent.

Some notable experts disagree, however. Stephen Roach of Morgan Stanley, for example, sees long-term rates climbing until they top 7 percent.

But Gross expects "almost identical returns" from stocks and bonds - 7 to 8 percent a year - over coming years.

Gross and Fuss see continued low inflation for the US and a favorable supply-demand picture for bonds.

In the US and Canada, government budget deficits have been reduced sharply, reducing their borrowing needs.

On the demand side, Gross notes, both institutional and individual investors are shifting into bonds. His fund added $20 billion in assets this year.

And Japan and China, with huge trade surpluses, are buying Treasury bonds "like gangbusters," he adds.

Gross likes 10-year US Treasuries: "There is not too much risk in these."

Fuss likes long-term, call-protected bonds, which cannot be recalled by their issuers if interest rates fall.