Bond Funds That Beat Money Market Malaise

Down. Week in, week out, that's the direction of money-market yields. With the average hovering around 3.1%, investors striving to eke out an extra few tenths of a point find it's often possible with an ultrashort-term bond fund. Like a money-market fund, it has high liquidity, low initial investment (usually $1,000), check-writing, and wire transfers.

But the yields are better. Neuberger & Berman's Ultra Short Bond Fund (800 877-9700) pays about 3.4%. The Sit New Beginning Investment Reserve Fund (800 332-5580) offers 3.5%.

RATE CUSHION. Money-market funds hold securities that mature in 50 to 60 days, but ultrashort funds typically hold ones with maturities two, three, or four times longer. As interest rates slide, money-market yields drop as income from maturing securities is reinvested at lower rates. But bond funds continue to reap rewards from their longer-maturity, higher-yield portfolios.

Managers of portfolios with bonds that mature in about six to eight months avoid big price fluctuations that can affect even short-term funds, whose holdings mature in one to three years. For Jeff Koch at Strong Advantage Fund (800 368-3863), the objective is "to provide more yield than a money-market fund" whose share price stays at $1 "and more price stability than a short-term fund."

A short-term bond fund's shares can move up or down two or three cents on a big swing in interest rates. But an ultrashort's shares seldom move by more than a penny. Make sure to check the prospectus for the quality of the portfolio. For example, the average bond in Investment Advisers' IAI Reserve Fund (800 945-3863) is rated AAA. Also emphasizing quality, Neuberger & Berman's Doug Taylor says he is avoiding corporate bonds and is 65% in Treasuries. Koch's more aggressive approach has the Strong fund about 80% in corporates, 20% in high-interest mortgages.

ODD LOTS. Another factor to check is total return. The IAI fund, for instance, yields only 2.9% currently but has a more impressive 6% total return for the year. And the Sit fund's Michael Brilley produced a 5% return. He has half the assets in bank CDs and other traditional short-term instruments, half in "high-rate corporate bonds issued a long time ago, which now have very short maturities." Often, says Brilley, such bonds are purchased in odd lots that other buyers pass up.

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