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Bear market gives boost to Florida bonds

But will investors return to stocks when the market rebounds? "I think we've seen a structural change,'' one fund manager says.

By HELEN HUNTLEY, Times Staff Writer

© St. Petersburg Times
published July 14, 2002


Pain for stock investors turned into gain for Florida bond fund investors last quarter, as well as for most other bond investors nationwide.

"It's the revenge of the nerds," joked Reid Smith, manager of the Vanguard Florida Long-Term Tax-Exempt Fund, one of the top-performing Florida bond funds.

"For years people said "Why do you own bonds? Who cares about bonds?' " he said. "Bond managers are feeling pretty good right now."

When investors fled the falling stock market last quarter, many of them turned to bonds, pushing interest rates down and prices up.

"Demand continues to outpace supply, and that's primarily because of what's going on in the stock market," said Eleanor Brennan, manager of the Scudder Florida Tax-Free Fund.

One reason Florida bonds have done especially well is that the supply of new bonds hasn't increased as much as it has in other states. New municipal bond issuance is up 19 percent over last year nationally but up only 8 percent in Florida. In addition, Brennan said, the state's finances are considered to be in better shape than those in some other large states, making bond defaults less likely.

"Florida has been less impacted by the broader recession," she said.

Skittish investors' focus on quality gave a big boost to insured long-term funds, which were the best performing category last quarter, according to the statistics compiled by Lipper. On average, the Florida insured funds were up 3.7 percent, intermediate-term funds up 3.24 percent, long-term funds up 3.07 percent and short-term funds 2.66 percent.

While a 3.7 percent total return works out to nearly 15 percent on an annualized basis, don't count on seeing anything close to that over the year ahead, especially if the stock market shows signs of coming back to life.

"We think the bulk of the returns in the fixed-income market are behind us in terms of appreciation," Smith said. But he said that even if prices don't climb much higher, the dividends will still look attractive.

Ron Schwartz, manager of the STI Classic Florida Municipal Tax Exempt Fund, said the outlook for the bond market is tied to what the stock market does.

"If the equity markets continue to show this sort of weakness, the Fed is not going to have any inclination to raise rates this year," he said. "But if the economy picks up and the equity markets start to pick up, then the Fed will start raising short-term rates."

If the Fed raises rates and investors switch back from bonds to stocks, bond prices will fall and bond investors will be the ones feeling glum.

But Schwartz said there's no way that all those investors who switched money from stocks to bonds will put everything back into stocks.

"I think we've seen a structural change," he said. "We're seeing a lot more individuals diversifying, taking another look at their asset allocations. People will put more into fixed income than they have in the past five years."

Short-term and intermediate-term bonds were more profitable for investors than long-term bonds last quarter. Brennan said the Scudder fund benefitted from that trend by emphasizing five-year to 15-year bonds. Schwartz said he captured the gains for the STI Classic fund by balancing short-term bonds with long-term bonds, a strategy known as a bar bell. Now both managers say they see more value at the longer end of the spectrum and are buying more 20-year bonds.

A couple of changes of note have occurred among Florida bond funds. Merrill Lynch folded its short-term Florida fund into the national Merrill Lynch Municipal Bond Fund-Limited Maturity Portfolio. In addition, Vanguard's insured fund dropped the "insured" title from its name and mandate and will move to the long-term fund category. Smith said the fund will continue to own many insured bonds but will have the flexibility to buy some lower-quality bonds.

-- Helen Huntley can be reached at huntley@sptimes.com or (727) 893-8230.

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