Lipper Research Senior Analyst Don Cassidy on "Business for Breakfast" 1060 KRCN - Handling Down Markets

A. Well, unless they want to risk further capital erosion, they do need toso something, not just sit tight. On average bond funds now show smalllosses for the year, meaning prices have dropped a little more than the netinterest earned.

Q. Are there many choices for bond fund investors, in a down market?

A. There are more now than just a few years ago.

• OLDER MOVES:
  Move to CDs.
  • Move to shorter-term bond funds.
  • Move to money funds.
• NEWER CHOICES:
  Buy TIPS funds or TIPS directly, or I-Bonds at the bank.
  • Buy some inverse bond funds.
  • Go short on one of the bond ETFs.

Q. Quite a list. Will people be able to keep their income streams if theydo this?

A. In many cases, no. If you move to shorter-term bonds or money funds, youwill give up some current income, but it would help preserve principal ifrates keep rising.

Q. Let's talk a little about TIPS funds.

A. Sure. A growing number of fund brands offer them. These are funds owningspecial Treasury bonds. Those bonds are linked to the CPI. So, unlike forregular bonds you get a little cash interest (maybe 2.5% or 3.0%), and youget an adjustment to principal that is driven by the inflation rate. So,such bonds tend not to decline in value when inflation and rates rise. Theyare variable-rate bonds. One problem is that your 1099 will show the fullamount (including the capital adjustment) as income, which will be morethan the cash interest you got. So, they are best held in IRAs or similarsheltered accounts.

Q. You mentioned inverse bond funds. Are those fairly new?

A. Yes, they are. The oldest goes back just about 11 years, and there arepresently only three of them. The others are only four and two years old.

• RYJUX (1995)
• RRPIX (2002)
• PCBDX (2004)

Q. How do these work?

A. They own options and futures on the bearish side of the bond market. So,the fund's NAV will move in the opposite direction of the prices ofTreasury bonds. They pay no interest, though.

Q. So, how would investors use these to make money?

A. You buy the funds (all no-load), and if bonds go down you make a pricegain. You could use the funds as hedges to your regular bond fund (orutility and REIT) holdings, or you could use them aggressively to try tomake money on the downside.

Q. And what about shorting bond ETFs?

A. Well, there are a few to look at. The long-term one is TLT, which ownslong Treasuries. LQD owns fairly long corporate bonds. And SHY ownsshort-term Treasuries. But remember, these portfolios pay interest becausethey actually own the bonds, so if you short them you will need to bepaying the interest. Again, you could use them as hedges or as aggressiveshort-side plays. I think the inverse bond funds are a better idea, sinceyou will not pay interest that way.

Q. In case listeners think rising rates will hurt stocks too, how aboutfunds that protect your money in a down stock market, Don?

A. Definitely. And again these are not recommendations but just ideas forpeople to look at?and decide for themselves!Rydex and Profunds both have various 'short side' funds that apply tospecific market niches - about 50 of them in all. These include the S&P 500,Dow 30, small-cap and mid-cap indices, the NASDAQ, oil & gas, and realestate. Most track the market one for one on the downside, but some do 1.5times or more. So, read the prospectus closely so you know exactly what youare getting into!

Q. Why would people buy these short funds instead of shorting a similar ETFif there is one?

A. Good point. The short-side funds do have a higher expense ratio. Manypeople have bond-type money in retirement accounts like IRAs, or inchildren's GTM accounts, and you are not allowed to go short in suchaccounts (because it requires a margin account). Buying a short-side fundallows you around that rule.

Q. Are you getting bearish, Don?

A. Just a personal opinion, but my level of concern is rising. I thinkinterest rates at 5% on the short end pose a rising competition to stocks,and I expect bonds to keep moving lower since the Fed is not done yet.Investors need to develop their own outlooks and resulting strategies.These are just ideas for those who may be getting worried.

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Don Cassidy is a Senior Research Analyst at Lipper specializing in fund flows, exchange-traded funds, (ETFs), closed-end funds, equity fund performance, and author of Trading on Volume (McGraw-HIll).