Taxable Bond Categories

It helps to think of closed-end bond funds in terms of categories, even though variations are extreme within most categories. The bond-fund groups listed in the weekly closed-end fund tables in Barron’s and The Wall Street Journal (on Mondays) provide a broad guide to fund types. The Taxable Closed-End Bond Fund Categories (see below) goes a bit further by separating several of the more diverse taxable bond groups in the weekly table into additional categories. The Closed-End Fund Association’s Web site (www.cefa.com) and Morningstar’s site (www.morningstar.com) identify a fund’s category in their profiles. The different sources aren’t always consistent in assigning funds to categories because some funds may straddle two or more categories.

Higher-Quality Income

The U.S. government, mortgage-backed bond, and investment-grade bond funds primarily target higher quality bonds. But a fund can be volatile even if its bonds are of top quality. For instance, U.S. government funds must invest at least 65% of their assets in U.S. government securities but could invest up to 35% in other, riskier debt such as foreign bonds. Further, such a fund could try to juice up its returns by betting on interest-rate moves through the use of leverage and derivatives. Thus, individual funds must be carefully analyzed. Funds in the U.S. government category include ACM Government Securities, Kemper Intermediate Government, and MSDW Government Income.

Investment-grade bond funds focus primarily on corporate debt rated triple-B or higher. Some U.S. government securities are typically mixed in, along with perhaps modest amounts of investment quality foreign debt. By and large, these plain-vanilla funds have low expenses and do not leverage. Current Income Shares, 1838 Bond-Debenture Trading Fund, John Hancock Income Securities Trust, Pacific American Income Shares, and Transamerica Income Shares are illustrative of this group.

Mortgage-backed bond funds primarily target various types of mortgage-backed securities and mortgage derivatives. The objective is high current income. Mortgage securities possess very high credit quality and attractive yields relative to U.S. Treasuries. But they are highly complex compared with the plain-vanilla Treasury. Monthly cash flows consist of interest and amortization of principal. Prepayments of mortgages by homeowners accelerate the maturity date in an unpredictable way and complicate the usual calculations of duration and yield. Mortgage funds are somewhat similar to U.S. government funds because most mortgage-backed securities have the direct or implied backing of the government. 
 

Taxable Closed-End Bond Fund Categories
U.S. Government Funds	U.S. Treasury and agency securities are the primary focus. Some non-U.S. government issues may be mixed in.
U.S. Mortgage Funds	The primary focus is on mortgage-backed bonds such as Ginnie Maes, which are issued or backed by the U.S. government or certain federal agencies.
U.S. Mortgage Term Trusts	These bond-like portfolios have a target maturity date at which they hope to return a predetermined amount of principal to investors.
Investment-Grade Funds	Corporate debt rated triple-B or higher is the primary holding. Some U.S. governments may be held.
Loan-Participation Funds	Senior secured floating-rate loans are the staple of these unique funds. Both continuously offered and exchange-traded funds are available.
High-Yield Funds	Relatively high income from investments in below-investment grade securities or junk bonds is the primary objective.
Multisector Funds	A mixture of U.S. government, high-yield corporate, and foreign-government bonds is typical.
Flexible-Income Funds	Managers move among different fixed-income sectors in their quest for income and appreciation. Some stocks may be held.
Global Funds	These broad-based portfolios hold U.S. and foreign bonds.
Emerging Market Debt Funds	These more volatile portfolios focus on developing market bonds.

© AAII Journal May 2000, Volume XXII, No. 4