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First-Half Bond-Fund Winners and Losers

Three of this year's losers are long-term winners.

Scott Berry, 06/20/2007

The first half of 2007 has proved a tricky period for most bond-fund managers and has likely rattled some bond-fund investors as well.

Entering the year, many fund managers expected the Federal Reserve to cut its target for the federal-funds rate (the rate banks charge one another for loans), but in recent weeks, those expectations have dried up as the economy has shown signs of strength at home and as interest rates have pushed higher overseas. The result has been falling bond prices and losses for many funds. Indeed, after spending much of the year's first half comfortably in positive territory, the average intermediate-term bond fund has now posted a small loss for the year to date through June 14. Many government-bond funds, municipal-bond funds, and world-bond funds have also dipped into the red.

Subprime mortgages have also caused problems for certain funds. Funds that focus on government mortgages have largely been spared, but funds that take on a little credit risk in the mortgage arena have been hurt. Both Fidelity Short-Term Bond FSHBX and Fidelity Ultra-Short Bond FUSFX have fought off problems to claw their way back into the top half of their respective categories, but Regions Morgan Keegan Select High Income MKHIX continues to look up at its average high-yield peer from that category's basement.

Overall, the high-yield category has been one of the bond world's few bright spots. With the economy still on firm footing and defaults still few and far between, junk bonds have performed quite well. Some of the category's leaders are actually on pace to deliver double-digit returns for the year. Not surprisingly, a few of these funds rank as first-half winners. And as our first-half losers show, six months is far too short of a time to judge a fund's long-term prospects. We remain fans of all three and think shareholders should stick with them despite their recent struggles. Short-term losses sting, but they shouldn't cause investors to lose sight of their long-term goals and objectives.

Northeast Investors Trust
This Fund Analyst Pick has continued to benefit from purchase decisions made in 2005. In that year, the fund suffered a bit from its exposure to troubled bond issuers, but patience has paid off as a number of them have rebounded nicely over the past 18 months. The fund delivered strong results in 2006 and ranks as one of the high-yield category's top performers in 2007, with a year-to-date return of 7.95%.

Fidelity Advisor High Income Advantage FAHYX
Rivals might say this fund has cheated its way up the charts in 2007. Rather than relying on bonds that aren't offering much in the way of yield, manager Tom Soviero has looked to individual stocks for extra return. And a 59% gain from Amkor Technology AMKR and a 34% gain from Teekay Shipping TK, both top-20 holdings, have helped the fund to a year-to-date return of 6.9%.

Legg Mason Partners Managed Municipals SHMMX
The fund has returned just 0.37% since the first of the year, but that's enough to top 98% of its muni national long-term category rivals. Managers Joe Deane and David Fare make bolder adjustments to duration (a measure of interest-rate sensitivity) than most peers and their moves look to be paying off. The fund also holds a slug of lower-rated bonds, which have held up better in recent weeks than more-interest-rate-sensitive higher-quality issues.

PIMCO Total Return
This fund was caught offside during the market's recent sell-off, and manager Bill Gross now appears to be in the minority of managers who believe that the Federal Reserve will cut rates in the second half of 2007. For the year to date, the fund has dropped 0.58% and ranks in the intermediate-bond category's bottom quartile. We wouldn't bet against it, though, as Gross has shown remarkable skill in guiding this fund through a variety of market environments.

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