Fundline: Bond funds take a dive

ByABC News
April 7, 2008, 12:08 AM

— -- You might expect to lose 10% or more from a stock fund during a bad quarter. But a bond fund? Almost never at least until this year.

Bond funds are the milquetoast choice among mutual fund investors: reliable plodders that give you a bit of income and relatively little volatility.

But some bond investors were unexpectedly slammed during the first three months of the year. RMK Select High Income, for example, plunged 22.4% in the first quarter (including reinvested dividends), according to Lipper.

You expect high-yield funds to be volatile. And the RMK fund is just a small fish in the big bond pool. Schwab YieldPlus, though, was aimed at more conservative investors. And it's a very big fish indeed; at least it was until the subprime mortgage meltdown. That fund plunged a shocking 19.9% in the first quarter.

What happened? These funds gave shareholders a taste of the pain that institutional investors suffered as the subprime mortgage market imploded.

The RMK fund invested in high-yield, low-quality bonds, which suffered badly during the subprime meltdown.

The Schwab fund had a huge 40.8% stake in mortgage-backed securities.

Both funds seem to be geared toward income-oriented investors who want a bit more yield than they might get from a money market fund.

Those investors enjoyed the higher yields both funds now yield more than 7%, thanks to their big price declines but they also absorbed far more risk than they might have bargained for.

Charbroiled emerging markets

How do you know when emerging-markets mutual funds are overheated? One clue: the emergence of funds that invest in progressively tinier countries. Right now, the indicator is registering somewhere between "charbroiled" and "toast."

Diversified emerging markets have certainly been hot: They soared a searing 36.8% in 2007, according to Morningstar. Such funds, in fact, haven't returned less than 23% in a calendar year since 2003.

Typically, as emerging markets overheat, investors begin looking for ever-tinier, ever-hotter markets to explore.