How 'Worst' Bond Fund Did It
WHILE MANY INVESTORS got hit by the bond market's recent selloff, a small bond-focused mutual fund that uses complex derivatives strategies took a particularly rough beating.</br></br>FBR Total Return Bond Fund returned a negative 19.08% in the month of July, the worst performance among more than 3,900 bond funds tracked by Lipper Inc. The fund bounced back to a peer-beating 8.60% gain in the first week of August, but its negative 15.53% return so far this year, through Friday, still ranks as the worst bond-fund performance of 2003. Yesterday, the fund was down a further 2.42%.</br></br>Investment professionals have speculated that other bond portfolios, possibly including some hedge funds, may have been bloodied in the bond-market tumble, but so far no significant examples have emerged. As interest rates surged and bond prices fell, the month of July saw taxable-bond mutual funds post their worst monthly loss in 16 years, since April 1987, Lipper said. However, the negative 2.51% monthly return on the average taxable-bond fund pales in comparison with the FBR fund's results. The average taxable bond fund is up 3.86% so far this year, through Friday.</br></br>Patrice Milton-Blue, co-manager of the $29 million FBR fund, says the fund's recent decline wasn't a complete surprise given the portfolio's investment strategy, which combines holdings of U.S. government bonds with transactions in fixed-income options and futures. In time periods when the bond market is particularly volatile, which it has been in spades these past several weeks, the portfolio "is going to be significantly more volatile than the market itself," Ms. Milton-Blue says.</br></br>Still, some investors in the FBR fund might have been caught unawares by the fund's recent beating. The fund's prospectus says the manager uses options and futures in an effort to boost return or "to protect the fund from adverse interest-rate movements." That also was the way the use of those derivatives instruments was pitched to fund investors in late 2001, when the fund's adviser sought and obtained shareholder approval to modify the fund's strategy to include use of options and futures.