Ultrashort Mutual Funds

Ultrashort funds typically own a variety of investment-grade debt from government agencies, corporations and mortgage issuers with an average AA credit-rating. Because these bonds will mature soon, ultrashort funds are less sensitive to interest-rate movements that can badly affect longer-term bondholders. The principal of such funds fluctuate, unlike a money-market fund, but the fluctuations tend to be minor. It's a low-risk option for getting a rate higher than conventional savings account or Certificate of Deposits (CDs).

Prices of such a Bond typically fall when rates rise. Both 1994 and 1999, for instance, were punishing years for bonds. Rising rates pushed intermediate-term bond funds down 4% on average in 1994, and the group lost 1.3% in 1999. But ultrashort funds, with their ability to renew themselves, rode the rising-rate trend to post average gains of 4.4% in 1994 and 2% in 1999.

Because they offer low-risk income, ultrashort bond mutual funds should be considered along with money-market funds and bank certificates of deposit (CD) as a good option to keep your cash for a short time. Look for low expense ratio funds. A few names are: Fidelity Ultra-Short Bond Fund (FUSFX), Payden Limited Maturity Fund (PYLMX), Schwab YieldPlus Fund (SWYPX), Vanguard Short-Term Tax Exempt Fund (VWSTX).

IFCD: To Prepare for Inflation

Whenever the economy decides to come back, it would bring with it another malice: inflation! (Don't you see a glimpse of that in the recent hike in oil price?). Remember that even the stimulus money has its origin in debt ... and someone needs to pay that back some day.

Inflation is defined as a sustained rise in the general level of prices of consumer goods and services and is measured by the non-seasonally adjusted Consumer Price Index (CPI) for All Urban Consumers. The CPI is a good measure of inflation as experienced by consumers in their day to day living expenses and is often referred to as the cost-of-living index. For getting additional information about the Consumer Price Index, visit the website of U.S. Department of Labor .

In an inflationary environment, today’s dollar may be worth only a fraction of a dollar next year. Inflation poses a problem for all investors, including holders of fixed-income investments, because the effects of inflation can erode the real value and purchasing power of coupon payments received in the future. To illustrate, it takes about $13000 in 2006 to buy what could be purchased for only $10,000 in 1996. For investors who rely on the stability and predictability of fixed-income investing, finding ways to limit or mitigate the effects of inflation are crucial. It’s clear from the example above that investors who are saving for some future expenditure, be it a major purchase or living expenses in retirement, could benefit from an investment that preserved purchasing power.

One of the newer ways to tackle inflation is inflation-linked CDs, or IFCDs. They've been around for about two years and enjoyed tremendous popularity. IFCDs have a floating rate coupon that changes monthly based on the government's inflation measuring stick, the Consumer Price Index, as compared to the same period a year ago.

For example, there is a two-year inflation-linked CD issued by LaSalle Bank and LaSalle Bank Midwest. The base coupon is 1.85% plus the year-over-year inflation rate. That brings the coupon to 6%, because the year-over-year Consumer Price Index rate is 4.15%. The year-over-year CPI rate adjusts monthly so every month a new rate is determined and that's added to the base rate to get the coupon. A five-year coupon with a base rate of 2% is also available with a combined rate of 6.15%.

IFCDs are FDIC-insured and can be purchased through brokers and financial advisers. One reason for the IFCD's popularity is that consumers like the inflation link being tied to the monthly coupon payment, versus the government's Treasury Inflation-Protected Securities, or TIPS, which adds the inflation premium to the principal, something the consumer doesn't receive until maturity.

Ultrashort Mutual Funds

Ultrashort funds typically own a variety of investment-grade debt from government agencies, corporations and mortgage issuers with an average AA credit-rating. Because these bonds will mature soon, ultrashort funds are less sensitive to interest-rate movements that can badly affect longer-term bondholders. The principal of such funds fluctuate, unlike a money-market fund, but the fluctuations tend to be minor. It's a low-risk option for getting a rate higher than conventional savings account or Certificate of Deposits (CDs).

Prices of such a Bond typically fall when rates rise. Both 1994 and 1999, for instance, were punishing years for bonds. Rising rates pushed intermediate-term bond funds down 4% on average in 1994, and the group lost 1.3% in 1999. But ultrashort funds, with their ability to renew themselves, rode the rising-rate trend to post average gains of 4.4% in 1994 and 2% in 1999.

Because they offer low-risk income, ultrashort bond mutual funds should be considered along with money-market funds and bank certificates of deposit (CD) as a good option to keep your cash for a short time. Look for low expense ratio funds. A few names are: Fidelity Ultra-Short Bond Fund (FUSFX), Payden Limited Maturity Fund (PYLMX), Schwab YieldPlus Fund (SWYPX), Vanguard Short-Term Tax Exempt Fund (VWSTX).

Opportunity in Long Term Municipal Bonds

Municipal bond funds are attractive investment vehicles for high tax bracket investors. These bonds invest in debt issued by cities and other municipalities. They usually offer lower, steady returns, but are tax-free. However, in recent weeks, Muni bond prices have fallen pushing yields higher, as investors moved money into the safer securities, such as short-term Treasury bonds.

In the muni-bond market, the yield curve is usually steeper than for Treasury bonds or corporate debt. That's partly because cities and states like to borrow money for long periods, while mutual funds prefer to buy shorter-term muni bonds. That means there's lots of supply of longer-term muni bonds, so issuers have to offer higher yields to sell them. Some hedge funds use this to their advantage by buying the higher yielding, long-term muni bonds and then chopping up those into short-term munis called tender option bonds (TOB) and selling those to other investors with lower yields. So the hedge fund ends up making money on the difference between long-term and short-term muni yields. Such trends had led to flattening of the muni yield curve but the market turmoil in August originating from sub-prome mortgages again pushed the yield for long-term muni bond higher.

After sharp losses in August, most mutual funds based on municipal bonds remain down by 5% or more so far this year. These include the $4.6 billion Eaton Vance National Muni fund (EANAX, Friday's close : 11.20, +0.02), the $5 billion Oppenheimer Rochester National Muni fund (ORNAX, Froday's close: 11.65, +0.01, down about 8.5% this year), the Goldman Sachs High Yield Muni fund (GHYIX, Friday's close: 10.71, +0.02), the Nuveen High Yield Municipal fund (NHMAX, Friday's close: 21.34, +0.03).

This downturn has presented opportunities for individual investors. Some investors may now give a serious look at such funds to take advantage of the current high yield of longer-term muni bonds.

Floating Rate Bond funds

For income-seeking investors, high-yield bond mutual-funds could be an attractive option. Such funds deal with corporate debt below investment-grade but these bonds are originated by banks rather than the companies themselves. So, it has less credit risk than junk bond funds but has more risk than a typical corporate investment-grade bond. The lien a bank has takes a higher priority in bankruptcy courts than a bond issued by a company itself. So in a bankruptcy, someone holding a corporate note might not get paid off, which does not happen in case of bank loans. These still shouldn't be confused with investment-grade quality bonds and investors should be cautioned that there can be losses due to defaults.

Floating-rate bond funds get their name from the fact that interest rates are reset every 30-90 days. The average interest-rate sensitivity of bank loan funds are about two-months long, which makes them comparable to short-term bond funds in terms of interest rate sensitivity.

Recently, yields on the 10-year Treasury shot through the 5% psychological barrier and last week touched five-year highs. The traditional bond funds are, no doubt, at risk for quite some time in future. On the other hand, bank rate loan funds seem to have placed themselves at a good position. If rates go down, then their income will go down but their NAV (Net Asset Value) won't be much negatively impacted. But, after all, these are bonds and so one shouldn't expect stock-like returns from this investment. Thus, fund expenses are a key to a good long-term success and should be seriously considered before taking the decision of investment.

The following funds could be considered by income-seeking investors. These can also be part of a well-balanced diversified portfolio:
Vanguard High-Yield Corporate Bond Fund (VWEHX) : Yield is around 7%, Expense ratio 0.26%.
Fidelity Floating Rate High Income Fund (FFRHX): Yield is around 6.4%, Expense ratio 0.74%.
Eaton Vance Floating Rate Fund (EVBLX): Yield is about 6.4%. Expense ratio 1.01%.

ETF for Junk Bonds

Last week, Barclays Global Investors launched the first Exchange Traded Funds (ETF) --the iShares iBoxx High Yield Corporate Bond Fund (HYG). The fund is the first one to invest in 'junk' bonds. Barclays now offers sixteen fixed-income ETFs, up from just six last year.

'Junk' bonds are those speculative securities that are rated below investment-grade and are considered risky investments. But, in the spirit of 'no risk no gain', such bonds also find investment from income-seeking individuals or institutions for their high level of yield. Some investors also buy such high-yield bonds as a tool to diversify investment portfolios. Such bonds can appreciate sharply during good economic times, when defaults are low and risk discounting is reduced. When markets gets into downturn, however, credit spreads can widen and high yield can bear the brunt.

The iShares iBoxx High Yield Corporate Bond Fund holds 50 issues and has an expense ratio of 0.5%. The fees on Barclays' other bond ETFs for the most part range between 0.15% and 0.25%. The relatively higher 0.5% expense ratio for the new ETF reflects the tougher liquidity challenges in the high-yield market.

On Friday, HYG closed at $104.25.

Inflation and IFCD

Inflation is defined as a sustained rise in the general level of prices of consumer goods and services and is measured by the non-seasonally adjusted Consumer Price Index (CPI) for All Urban Consumers. The CPI is a good measure of inflation as experienced by consumers in their day to day living expenses and is often referred to as the cost-of-living index. For getting additional information about the Consumer Price Index, visit the website of U.S. Department of Labor .

In an inflationary environment, today’s dollar may be worth only a fraction of a dollar next year. Inflation poses a problem for all investors, including holders of fixed-income investments, because the effects of inflation can erode the real value and purchasing power of coupon payments received in the future. To illustrate, it takes about $13000 in 2006 to buy what could be purchased for only $10,000 in 1996. For investors who rely on the stability and predictability of fixed-income investing, finding ways to limit or mitigate the effects of inflation are crucial. It’s clear from the example above that investors who are saving for some future expenditure, be it a major purchase or living expenses in retirement, could benefit from an investment that preserved purchasing power.

One of the newer ways to tackle inflation is inflation-linked CDs, or IFCDs. They've been around for about two years and enjoyed tremendous popularity. IFCDs have a floating rate coupon that changes monthly based on the government's inflation measuring stick, the Consumer Price Index, as compared to the same period a year ago.

For example, there is a two-year inflation-linked CD issued by LaSalle Bank and LaSalle Bank Midwest. The base coupon is 1.85% plus the year-over-year inflation rate. That brings the coupon to 6%, because the year-over-year Consumer Price Index rate is 4.15%. The year-over-year CPI rate adjusts monthly so every month a new rate is determined and that's added to the base rate to get the coupon. A five-year coupon with a base rate of 2% is also available with a combined rate of 6.15%.

IFCDs are FDIC-insured and can be purchased through brokers and financial advisers. One reason for the IFCD's popularity is that consumers like the inflation link being tied to the monthly coupon payment, versus the government's Treasury Inflation-Protected Securities, or TIPS, which adds the inflation premium to the principal, something the consumer doesn't receive until maturity.

6.00% APY from HSBC

The HSBC Direct Online (HSBCdirect.com) announced that it would give 6.00% APY interest to new money deposited in any old or newly opened savings account until April 30th, 2007. Currently, this is the highest rate among all savings accounts in USA and it has no minimum deposit or fee requirements. It's even better than 3-month CD rates (highest level is near 5.5% APY) and has extra advantage that you can withdraw your money anytime you want.

So if you have money that you need to invest for a short time, this is a good place to keep. Other banks like EmigrantDirect.com is offering 5.05% APY in savings accounts. Most money market funds (MMF) are offering similar yield rates.

Disclaimer: MyDollar has no connection whatsoever with the sites mentioned above. We give such information only because we think our readers may benefit from it.

Total 100 pts Rate Cut in 2007, says Bill Gross

Bill Gross, the widely respected Guru of Bonds and Managing Director of Pimco, the world's largest bond fund, predicted in an article on the Pimco website that the Federal Reserve would go for rate cuts totaling 100 points which will reduce the fed funds short-term rate from its current level of 5.25% to 4.25% by late 2007.

On Friday, Treasurys sold off on worries that surprisingly robust jobs creation in December would make it hard for the Fed to cut interest rates anytime soon and some even started talking about rate hike making the investors of both stocks and bonds nervous. Early on that day, the Labor Department reported that 167,000 jobs were generated and average hourly earnings jumped by 8 cents or 0.5% last month.

The most recent estimate of inflation placed 3rd-quarter real gross domestic product (GDP) at a 2% real seasonally adjusted annual rate, slightly lower than a prior estimate of 2.2% , and marking the slowest growth since the 4th quarter of 2005. However, Gross said that the Federal Reserve would be most interested in nominal GDP, a different measure that, unlike real GDP, does not reflect the impact of inflation. Nominal GDP fell to a 3.8% growth rate in 3rd quarter from its 2nd quarter number of 5.9%. During the past 15 years, the economy has trended to an average nominal growth rate of 5%, according to Gross. The Fed this year will need to drop the overnight rate to 4.25% to recapture that level of nominal growth, he wrote.

"Many investment managers are almost oblivious to nominal U.S. GDP levels these days – as a matter of fact, the Commerce department itself nearly buries the nominal number 8 or 9 paragraphs deep in its quarterly press releases. There are times when you can’t even find it in the text. But it is nominal, not real GDP that reflects the return on a nation’s capital, and nominal GDP that points towards our ability to pay our bills," wrote Bill Gross.

Here is the full article at Pimco site. [photo courtsey: Pimco]

Ultrashort Mutual Funds

Ultrashort funds typically own a variety of investment-grade debt from government agencies, corporations and mortgage issuers with an average AA credit-rating. Because these bonds will mature soon, ultrashort funds are less sensitive to interest-rate movements that can badly affect longer-term bondholders. The principal of such funds fluctuate, unlike a money-market fund, but the fluctuations tend to be minor. It's a low-risk option for getting a rate higher than conventional savings account or Certificate of Deposits (CDs).

Prices of such a Bond typically fall when rates rise. Both 1994 and 1999, for instance, were punishing years for bonds. Rising rates pushed intermediate-term bond funds down 4% on average in 1994, and the group lost 1.3% in 1999. But ultrashort funds, with their ability to renew themselves, rode the rising-rate trend to post average gains of 4.4% in 1994 and 2% in 1999.

Because they offer low-risk income, ultrashort bond mutual funds should be considered along with money-market funds and bank certificates of deposit (CD) as a good option to keep your cash for a short time. Look for low expense ratio funds. A few names are: Fidelity Ultra-Short Bond Fund (FUSFX), Payden Limited Maturity Fund (PYLMX), Schwab YieldPlus Fund (SWYPX), Vanguard Short-Term Tax Exempt Fund (VWSTX).