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Fund Spy

Morningstar Fund Spy

Some Cliches Never Go Out of Style
There's no free lunch, and you get what you pay for. That's the story for multisector-bond funds that tried to juice up their yields by adding emerging-markets bonds to the boring old German and French government debt in their foreign portfolios. Emerging-markets bonds held up surprisingly well for a long time after stocks in those regions plunged. But when the Russian ruble ran into trouble, the bottom fell out on the debt side as well.

That was bad news for Merrill Lynch World Income in particular. In 1997, that fund swapped all its developed-markets bonds (about 30% of assets) for emerging-markets fare. It has paid the price. Through August 21, it was posting a staggering year-to-date loss of 21.4%. The average multisector-bond fund was down a mere 0.7%. The problem wasn't just the move to emerging markets per se, apparently, but which countries and bonds the fund chose. (For example, it had 13% in Russia at the end of July.) Rival funds with significant emerging-markets stakes didn't lose nearly as much.

To its credit, Merrill Lynch World did give a better explanation than "We want more yield" when it made the switch to emerging markets. Its managers argued with some justification that developed-markets bonds were riskier than many people thought, given the difficulty of predicting currency fluctuations, and didn't pay yields commensurate with that risk. But the results have been painful. The lesson is as old as the cliches: If a bond fund is paying a higher yield, it's taking more risk to get it.