Some municipal bond fund investors are in for a surprise when they receive their October statements. After producing an average total return of 8.28% through September this year, according to Lipper Inc., many shareholders will be staring at glaring losses for October.
While data is not yet available for the funds' performance during the last week of the month, Lipper data indicates that the average municipal bond fund has so far produced a negative total return of 3.32% in October.
The principal erosion may come as a shock to the many that sought out bond funds as a haven from stock market volatility. Municipal bond funds -- not including money market funds -- had a net inflow of $2.32 billion in September, excluding reinvested dividends, according to information the Investment Company Institute released this week.
Year-to-date net new cash flow has so far topped $17.5 billion, surpassing net inflows of $11.6 billion for all of 2001, and putting the funds on track for their best year in nearly a decade, according to the Washington, D.C.-based institute.
Overall, taxable and tax-exempt bond funds had a net inflow of $15.9 billion in September, and are up over $100 billion this year, compared to stock funds, whose net outflow of $16.1 billion in September left them down $18.7 billion for the year to date.
Some investors, likely aware of the impact rising bond yields would have on their funds, have already begun to pull out. Preliminary data for the two-week period ended Oct. 23 indicates the funds had net outflows that cost them $1.47 billion, breaking a streak of 11 consecutive weeks of net inflows that bolstered the funds by $4.87 billion, according to data collected by U.S. Bancorp Piper Jaffray.
Even those bond fund complexes that did not see net redemptions were likely not to see much in the way of new share purchases late in the month, as a rising awareness of bond market volatility set in.
OppenheimerFunds Inc. municipal bond fund group saw new share purchases fall precipitously in October to near zero from about $50 million a week since the second quarter. A mutual fund shareholder can "see his NAV in the newspaper every morning" to monitor fund performance, said Dan Loughran, a portfolio manager at the firm.
But at least one bond fund monolith -- the Vanguard Group -- has taken steps recently to address the possibility that not all investors caught up in this year's bond craze may be aware of the perils the funds may hold. On Tuesday, the Valley Forge, Penn.-based mutual fund complex posted a warning on its Web site for investors.
Titled "Plain Talk on Bond Risks," the warning can be reached from the main page for individual investors on the firm's Web site. It seeks to explain, among other things, the damage that rising interest rates can cause.
"We've discerned from our discussions with prospective bond fund investors that they harbor a number of misconceptions about bond funds," the Web site states. A recent test of investor knowledge conducted by the firm found that 70% of respondents did not understand that bond prices move in the opposite direction of interest rates.
"Money is pouring into bond funds at a record pace in 2002 and we want to make sure that investors understand interest-rate and other risks inherent to bond fund investments," said Catherine D. Gordon, who heads the firm's investment counseling and research group, in a prepared statement.
The vast majority of bond fund investors, however, have demonstrated buying patterns that reflect some knowledge of interest rate risk, according to research conducted by Lipper.
More than 90% of the net new money that flowed into bond funds in October was placed with short- and intermediate-term funds, rather than long-term funds, according to the fund tracking service. The shorter-term bonds those funds invest in are prone to less interest rate risk. Nevertheless, long-term funds captured more than $1.2 billion of net inflows in October, according to Lipper.
