WITH stocks going nowhere fast, more and more investors are turning their attention to bond funds.
For the most part, bond funds come in two shapes: those that invest only in low-risk, investment-quality bonds and those that invest in junk bonds.
The Transamerica Premium Bond fund walks the fine line between those two popular styles of investing.
“There’s a big price divergence between investment-grade bonds and bonds that aren’t investment grade,” said portfolio manager Matthew Kuhns. “We typically focus on bonds rated just below investment grade, but which our analysis indicates are likely to be upgraded.”
But the fund also keeps a small position in U.S. Treasury bonds to reduce risk.
“Normally, we try to keep it a 70-30 split between corporates and treasuries,” noted Kuhns. “But right now, the portfolio is about 85 percent corporates because going forward, corporate bonds offer the most attractive yields.”
Kuhns runs a focused portfolio, with only 20 to 30 holdings in the fund.
“We run a concentrated fund, because I like to keep 3 to 5 percent in the names I really like because it allows us to make the most of our credit leverage expertise because we really know our companies well,” Kuhns explained.
Kuhns doesn’t worry, however, about placing too many bets in one given sector. The emphasis is on bottom-up, company-focused research, and if a number of good companies are all in one sector, Kuhns will buy them anyway.
Right now, the fund has a big bet on bonds issued by companies in the defense industry, including big positions in Lockheed Martin and Northrop Grumman.
“The defense industry is in a great place right now,” said Kuhns. “This is an industry that’s been facing government cutbacks since 1986. Now, in the Bush budget that was released on Monday, defense spending is expected to grow 5.7 percent – from $296 billion to $310 billion.”
Kuhns also likes the auto sector, where he has big positions in General Motors and Ford Motor Credit.
But the more recent additions to the fund have not come from the defense or automobile sectors.
Instead, Kuhns is looking far and wide for good companies in other sectors, including retailing.
“One fairly new holding for us is Kmart, a real interesting turnaround story,” he said. “There’s a new CEO, Chuck Conaway, who was hired from CVS and is savvy about managing inventories, boosting comp-store sales and closing underperforming stores. He’s already getting results. The bonds have an investment-grade rating from Moody’s, but one notch below at Standard & Poor’s. We think the company will get upgraded later this year.”
Kuhns noted that Kmart’s equity shareholders are also reaping the benefits of the Conaway-led turnaround, with the stock up more than 60 percent so far this year.
It’s not the first time that Kuhns has found good bond buys by paying attention to stock market moves.
When Calpine, a company that builds power-generation plants, began running up the stock market charts, Kuhns started studying the bonds. And then he bought.
“This is another company that was undervalued because the bonds were just below investment grade,” he pointed out. “We bought, and we think they will be upgraded within six to 12 months.”
The Transamerica Premier Bond fund registered a gain of 8.2 percent last year, and is up 3.37 percent this year. Its average annual gain since it was launched in 1995 is 6.79 percent.
fund at a glance
Name Transamerica Premier Bond
Portfolio manager Matthew Kuhns
Top holdings, current yield
U.S. Treasuries, 4.625%
Lockheed Martin, 8.5%
Northrop Grumman, 7.75%
Gains
2000: 8.2%
YTD: 3.37%
Phone
800-892-7587
Web site