HOW TO PLAY IT-The post-QE3 yield chase
* Reliable investment income scarcer amid low interest rates
* Some fund managers bullish on high-yield corporate debt
* Emerging market bonds, high-yield munis seen as promising
By David K. Randall
NEW YORK, Sept 28 (Reuters) - This is not an easy time for investors who depend on the bond market for income.
With the Federal Reserve's Sept. 13 announcement that it would start a third round of quantitative easing, the central bank continued its attempt to drive interest rates lower to spur lending and consumption.
While that may be good for borrowers who can lock in record-low mortgage rates, sinking bond yields mean that dependable investment income is harder to find. The benchmark 10-year U.S. Treasury note, for instance, offers a yield of just 1.63 percent, well below the core inflation rate of 1.9 percent. Five years ago, the 10-year Treasury yielded 4.53 percent, according to data from the St. Louis Fed.
The low interest rates are forcing many people to put more risk in their portfolios, said Michael Mata, portfolio manager of the $755 million ING Global Bond fund (IGBIX).
Fund flows into volatile emerging market bonds, for instance, have increased to $14.7 billion so far this year from just $1.6 billion in all of 2007, according to Lipper, a Thomson Reuters company.
To find income now, fund managers and financial advisers are turning to a wider range of bonds, from emerging market corporate debt to high-yield municipals. Here are some of their strategies for picking up yield - without taking much risk.
The search for income has turned even high-yield corporate bonds on their heads. The Barclays U.S. high-yield index fell to a record low of 6.15 percent on Sept. 20, in part because investors have bid up the price of noninvestment-grade debt, pushing yields lower.
Still, Carl Kaufman, who manages the $2.6 billion Osterweis Strategic Income Fund, likes the sector.
U. S. high-yield corporate bonds "still have the best risk-reward relationship in the marketplace," he said.
Kaufman, whose fund can buy or sell any bond class regardless of its geography or duration, says he is picking up corporate high-yield debt because it offers the most protection from sudden interest rate changes and the category includes new issues from higher-quality companies like motorcycle maker Harley-Davidson Inc and retailer Kohl's Corp.
Nearly 70 percent of his fund's assets are in corporate bonds, followed by about 12 percent in convertibles, according to Morningstar, and his fund has an average credit quality of single-B.
Kaufman is staying away from all Treasury bonds. "They may protect you from a depression, but I think I can find companies that will pay their debts even in the worst-case scenario," he said.
The fund is focusing on securities with durations of one to four years and yields of between 3 percent and 5 percent, Kaufman said. His largest holdings include Lion's Gate Entertainment Corp and Dollar General Corp, according to Morningstar.
Krishna Memani, director of fixed income at Oppenheimer Funds, also favors high-yield corporate and municipal bonds over the mortgage-backed securities that the Fed will purchase as part of its easing program.
"High-yield assets still provide decent income - they just don't provide the yield that they used to," he said.
Solid corporate balance sheets and strong fundamentals, like liquidity, also bring investors a better measure of safety than these bonds had in the past, he said.
Municipal bonds in areas of California and other states with high foreclosure rates could also offer attractive levels of yield for investors who do their research, Memani said.
The $6.9 billion Oppenheimer Rochester National Muni fund , for instance, holds nearly 60 percent of its assets in securities rated single-B or lower, according to Morningstar. That helped it gain 15.3 percent for the year and yield 6.9 percent, but Morningstar calls its "aggressive" strategy risky.
ING's Mata said his fund had recently rotated out of U.S. high-yield debt and was putting more assets into emerging market bonds, where he sees better values.
Some sovereign bonds issued in Latin America look attractive, he said. Benchmark 10-year bond yields are at 5.2 percent for Mexico and 9.8 percent for Brazil, for instance.
Mata also has been buying corporate debt denominated in U.S. dollars but issued by companies in Latin America. His fund currently holds positions in state-owned oil companies Petroleos Mexicanos and Petroleos de Venezuela, which offer coupons ranging from 7 percent to 9 percent, according to Morningstar.
Security Ballew Wealth Management Chief Investment Officer T. Doug Dale is increasing his holdings of exchange-traded funds ETFs with emerging market corporate debt.
"You can get the same yields we had back in 1999 and 2000, and most of their balance sheets are better than in the developed world," said Dale, whose Jackson, Mississippi, firm has $500 million in assets under management.
One of his favorite funds is the $21 million iShares Emerging Markets Corporate Bond ETF, which yields 3.3 percent. Nearly 40 percent of the fund's holdings are in bonds with durations of seven to 10 years, according to Morningstar.
Cost-conscious investors should be aware that the small size of the fund also results in a relatively high bid/ask spread of 0.69 percent.
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