TAKING STOCK: Bond funds

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Dear Mr. Berko:

Last May, you told my husband not to invest $40,000 in the Class A shares of the Franklin Income Fund, telling him that FKINX was "very risky." We partially took your advice and invested $20,000 at $2.44 a share because the yield was 4.8 percent. Now the fund is down by 30 cents a share, to $2.14, and we've lost almost $2,500 on what we thought was a safe investment. We would like to invest the remaining $20,000 in that fund if you think it could go down to $2 a share, which would give us a 6 percent yield on our second $20,000 and a 5.4 percent yield on our total investment. What do you think?

-IG, Detroit

Dear IG:

You've gotta be dumber than a herd of androgynous wombats to buy an open-end fund and pay a 4.25 percent commission. Unlike the case with a common stock, buying FKINX when it falls in price is unwise because the momentum of its $83 billion portfolio acts like a riptide. Realizing that Federal Reserve Chairwoman Janet Yellen is looking for an excuse to raise interest rates, I'm likelier to recommend that you sell FKINX.

I'm loosely familiar with Sir Isaac Newton's observations in "Philosophiae Naturalis Principia Mathematica," particularly the notion that what goes up must come down. However, I'm more concerned with Murphy's Law and its relationship to Newton's law of universal gravitation: "When something comes down, it won't come down where or when you expect it to come down, unless you don't expect it to; at that point, it will." And frankly, I haven't the foggiest idea whether FKINX will reach $2.

FKINX, run by Ed "Fast Eddy" Perks, is an $83 billion open-end fund, and among its largest holdings are the oil stocks of Royal Dutch Shell, BP and Chevron. Fast Eddy's FKINX also owns $27 billion in high-yielding (junk) bonds, more than any other mutual fund I know. A lot of Fast Eddy's junk is so thinly traded (illiquid) that-based upon the average trading volume during the past year-it may be terribly difficult to sell, and that's scary. Fast Eddy also owns a big batch of oil patch bonds that have been clobbered by low oil prices-Linn Energy, Halcon Resources, Energy XXI and others currently trading at 50 to 75 percent discounts to par, some with current yields over 35 percent. Last August, disappointed investors took $1.5 billion out of FKINX, which, except for one in 2008, was the largest pullout in its 67-year history. And more may pull out when FKINX reduces its dividend next year.

Bonds are making investors nervous. The U.S. debt market, with $50 trillion in bonds outstanding, is the largest bond market in the world-about twice the combined size of the world's five largest foreign stock exchanges. It's become an unwieldly, over-huge market of low interest rates, fueled by the massive issuance of new corporate debt and naive investors willing to take absurd risks. During the past three years, the growth in new-issue U.S. junk bonds has exceeded $200 billion a month and fueled the issuance of new, super-large bond funds. This is coming at a time when the global economy is limping and record debt ratios of countries around the world indicate potential financial crises.

The Federal Reserve realizes that the nearly exponential growth in the size of the world bond market (over $98 trillion) suggests that it may be too big to fail. The Fed also recognizes the damage it could cause if it raised rates just 25 basis points. When central bankers begin raising rates, bond prices will fall, and all bond funds will take losses. And those using leverage (borrowed money) will be hurt badly. The alarming danger for bond fund managers is that spooked shareholders will be making mass redemptions. Because many of these high-yield bonds have thin, nearly illiquid markets, their liquidation might create wide, disorderly and panicked price swings. The Fed is acutely aware of this problem and has been reluctant to raise rates. When the Fed does decide to raise rates, I may go fishing for a week.

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Please address your financial questions to Malcolm Berko, P.O. Box 8303, Largo, FL 33775, or email him at mjberko@yahoo.com. To find out more about Malcolm Berko and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate website at www.creators.com.

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Published: Tue, Dec 15, 2015