By Christopher Lazzaro,
Vice President, Financial Advisor Relations,
Loomis, Sayles & Co.

Selecting an individual bond or bond fund based solely on yield could be a costly mistake. A bond ladder, an ultra-conservative strategy that invests even amounts among bonds that mature at regular intervals, is simple enough, but may offer only modest potential for capital appreciation.

Maximizing fixed income allocations is becoming a paramount concern The most frequently cited considerations among bond investors are interest rates and inflation. Most market watchers agree that we are entering an extended period of rising interest rates, after more than 20 years of steadily declining rates. There seems to be no consensus on "the Street" about inflation, although anyone who drives a car, heats a home or shops for groceries might have a more definitive opinion.

Rising interest rates and inflation are universally viewed as bond kryptonite. Yet, they are only two of many considerations that must be weighed as part of the portfolio construction process. Determining just the right mix is critical . A number of factors must be addressed including:

  • Global yield curves

  • Currency fluctuations

  • Global credit cycles

  • Federal Reserve Bank/Central Bank policy

  • Geopolitical concerns

  • Default rates

  • Bond upgrades/downgrades

One-Stop Global Diversification and Wealth Management Approach

If that is not enough to cause you a few sleepless nights, there are always more questions to ponder. Are high yield and emerging market bonds worth the risks? When is the best time to get in/out of high yield and emerging markets? Is it time to overweight or underweight corporate bonds? Do Treasury Inflation Protected Securities (TIPS) make sense now? Will Japan raise interest rates further? Whoever said bonds are boring may want to rethink that statement.

You would have to devote much time to digest all the news and research required to make truly informed decisions about each segment of the global fixed income markets and even more importantly about how assets should be allocated across the spectrum. To simplify the process you may want to consider researching options within the multisector bond fund category.

Morningstar, the Chicago-based mutual fund researcher, defines the multisector bond fund category as "funds that seek income by diversifying their assets among several fixed income sectors, such as U.S. government obligations, foreign bonds and high yield domestic debt securities."

In conducting due diligence for multisector bond fund managers, make sure you or your financial advisor, looks for investment firms distinguished by the extensive depth of portfolio management and research staff experience, as well as breadth of market coverage. The wider, less restrictive guidelines under which multisector bond strategies are managed necessitate expertise across the entire global fixed income spectrum. Best of breed managers in the multisector category should cover every major bond market sector domestically and globally and have significant capabilities in currency analysis.

Income + Capital Appreciation

Closer examination of the funds in this category reveals that many explicitly include an important total return component in their objectives, which may further add to the appeal of a multisector strategy. A total return-driven approach to bond investing can help keep pace with inflation over the long term while potentially minimizing the need to liquidate a portion of the principal balance to meet current income needs.

Careful Selection of Investment Manager

Multisector bond funds typically have a low correlation, or R-squared, with the overall bond market and other types of bond funds. R-squared is a statistical measure that represents the percentage of a fund's movements that are explained by movements in a benchmark index. Multisector bond funds, for the most part, don't tend to move in complete lockstep with the broad bond market indexes, so performance is more dependent on the investment manager's ability to effectively execute its strategy.

This is why careful investment manager selection is a critical component of fund evaluation in this category. According to Morningstar's Principia database as of January 31, 2007, the average R-squared for a multisector bond fund is 51 when compared to the Lehman Brothers Aggregate Bond Index, the widely used proxy for the bond market. An R-squared of 100 would indicate that a fund's movements would be perfectly correlated to any movements in its respective benchmark.

Your personal situation and risk tolerance will dictate the most appropriate course of action. Still, a disciplined multisector bond fund could prove to be an important tool, as the migration from wealth accumulation to income distribution, which is already underway, accelerates.

* Christopher Lazzaro is vice president, financial advisor relations at Loomis, Sayles & Company in Boston, Massachusetts. For more information about Loomis Sayles' multisector bond strategies you may contact him directly at clazzaro@loomissayles.com.

Foreign investments involve special risks including greater economic, political and currency fluctuation risks, which may be even greater in emerging markets. High yield securities are subject to a high degree of market and credit risk. In addition, the secondary market for these securities may lack liquidity which, in turn, may adversely affect the value of these securities and that of the Fund. Mutual funds that invest in bonds can lose their value as interest rates rise and an investor can lose principal.

This article, which is a service provided by Loomis Sayles, is for informational purposes. It should not be construed as investment advice. We believe the information in this article is reliable, but we cannot guarantee its accuracy. Opinions expressed reflect subjective judgments and will evolve as future events unfold.