by Reshma Kapadia

Few people ever want to be stuck in the middle. But in the bond world, that may be the perfect place to be, even if the secret of this strategy is already out.

So-called intermediate-term bonds, which mature in more than a few years but in less than 10 years, have been hot for over a year now. Indeed, funds that include the Jan Brady of bonds have attracted more than $100 billion in new money since the beginning of 2009, more than any other type of bond fund.
And it’s easy to see why: The bonds typically have higher yields than short-term bonds, and some analysts say their prices won’t fall as dramatically as those of long-term bonds if the Federal Reserve raises interest rates to head off inflation. What’s more, some longtime bond investors are turning their attention to intermediate bonds issued by companies whose finances aren’t the best. Their ratings of B or BB are just below investment grade, but the yields are certainly eye-popping: as high as 9.25 percent.
That, of course, comes with some risk. The high-yield bond market has taken a beating recently as many investors, spooked by the credit problems in Europe, have run away from any investment they consider risky. But an improving economy can shore up an issuing firm’s balance sheet, reducing default risk and pushing bond prices higher, says Kathleen Gaffney, comanager of the top-performing Loomis Sayles Bond fund. They can be the “crème de la crud,” says Zane Brown, fixed-income strategist for Lord Abbett, which manages $94 billion for clients.

To be sure, analysts say investors who need money fast should probably stay away from all intermediate bonds. Prices can swing dramatically; junk bond prices, as a group, fell more than 4 percent in May alone. And anyone expecting a repeat of the big gains bonds had in 2009 will likely be disappointed. Companies and governments also have billions in debt coming due in the next couple of years, and any difficulty in refinancing it or economic stumbles could send prices of bonds and bond funds tumbling.
But if the U.S. economy continues to recover, three- to seven-year bonds of slightly lower credit quality could be a decent place to invest for a while. “With a slower recovery, you might as well pick up some returns in the meantime,” says Anne Briglia, senior fixed-income strategist at UBS Wealth Management.

The Middle of the Bond Road

Dodge & Cox Income (DODIX)
The fund has a contrarian streak, owning fewer Treasury bonds and more corporate bonds than its peers, with an average duration of about four years. The fund’s five-year average return beat 85 percent of peers.

MFS Bond (MFBFX)
Almost half of this fund’s portfolio is in BBB bonds, and a quarter of its holdings are higher-quality high-yield bonds. One downside: a 4.75 percent sales charge if you buy the fund directly from the company.

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