Which Bond Funds Are Pulling Up the Rear in 2008?

It has been a tricky year so far in 2008 for bond-fund investors. The credit crunch has continued to play out, policy makers and risk takers have fuelled rallies and Cassandras have stalled them. Last week, my colleague Scott Berry examined some managers who have been navigating this environment well. I thought I'd turn his article on its head and look at some of those who have been struggling through the year's first half. In some cases, these funds remain very strong options that have just hit a rough patch, while in other instances the crunch has exposed funds' inherent flaws.

To assemble a reasonably sized list of the downtrodden, I screened for fixed-income mutual funds that have been among their respective Morningstar categories' worst 10% from Jan. 1 to June 30. To keep the results relevant for more readers, I eliminated funds with asset bases below $500 million. The process yielded 44 funds, and I'll discuss a handful of the larger and more prominent ones in more detail below.

 Fidelity Advisor High Income Advantage (FAHDX)
Year-to-Date Return: -2.80%
We've told folks over the years to be careful with this fund. Manager Tom Soviero doesn't try to position the fund as a core high-yield offering, but rather as one that will offer a fair amount of capital appreciation. He invests in lower-quality bonds, convertibles, and straight equities to a greater degree than most rivals. That recipe has met with volatile results over time, including during the first six months of 2008. Though the fund has a good record of bouncing back after taking hits in the past, and it likely will do so again, it could continue to face a headwind if high-yield issuer defaults pick up, as typically happens during a recession, but hasn't happened yet.

 Metropolitan West Low Duration (MWLDX)
Year-to-Date Return: -4.03%
We hold this fund's manager in high regard and we have been surprised with how poorly this short-term bond fund has done. Though its longer performance history isn't blemish-free, the fund's managers had begun gearing up for economic weakness and risk reduction in the early part of 2007. Though they got that part right, they expected the corporate bond market to be the epicenter of a sell-off rather than the high-quality asset-backed securities they have owned. The managers continue to believe in asset prices' tendency to mean revert, so they're sticking with, and adding modestly, to these bonds. It could be some time before a turnaround, though, which makes patience a necessary virtue for shareholders here. The question is whether it's practical to expect most short-term bond investors to possess that quality in the necessary measure.

 Oppenheimer Rochester National Municipals (ORNAX)
Year-to-Date Return: -12.96%
This high-yield muni offering is its largest national offering, but this section could apply to most of the tax-exempt mutual funds managed by the Rochester team. The group focuses on maximizing yield and when it finds bonds with plump coupons, it will hold on for the long term. If you look at the funds' results over long periods, you'll find they're stellar. The rub is that these bonds may experience quite a lot of short-term volatility. Shareholders of these funds have clearly seen the downside of that volatility during the past 12 months. As in the other cases mentioned above, investors must stick around for a while to reap the benefits. Another looming question here is how this set of funds will fare if redemptions pick up: A lot of their bonds tend to be thinly traded, and selling them into an unreceptive marketplace could hurt.

 Schwab Yield Plus 
Year-to-Date Return: -29.15%
Unlike the other funds on this list, this ultrashort bond fund is an outright pan. Though it is designed to be among the most stable holdings in shareholders' portfolios, it held a lot of subprime and other lower-quality bonds. After it started to underperform as a result of those struggling postions, shareholders began heading for the exits. That led to a raft of forced selling of securities by the portfolio managers, resulting in permanent losses. Academics might be writing about this fund for years. It wouldn't be a shock if its board moved to liquidate the fund, as the trustees of troubled rivals SSgA Yield Plus and Evergreen Ultra Short Opportunities have done in recent months.

 Western Asset Core Plus (WACPX)
Year-to-Date Return: -3.76%
Until about 12 months ago, this fund had been one of the intermediate-term bond fund category's best performers over time, including during times of stress. Since then, it has been one of the group's worst, thanks to deteriorating corporate (including high-yield) and mortgage bond prices. In a way, this fund may be like its sister offering,  Legg Mason Value (LMVTX) (Western Asset is a unit of  Legg Mason .) Though both funds' managers are willing to take on risk that you would expect to lead to performance inconsistencies--here that has meant bets on junk bonds, for instance--each fund had been extremely steady over time. It's probably a better idea to expect this fund to bounce around a bit more from year to year than it has since its July 1998 inception, though we still think it has the chops to outperform over time.