Morningstar Advisor - April/May 2010 - 21

International Stock DODFX. It does have different managers and a different portfolio than one would get from simply gluing the other two together, but the end result will likely be fairly close.

bonds are affected by the demand for loanable funds. During an economic expansion, the demand for funds tends to cause interest rates to rise, increasing the costs of borrowing. During an economic contraction or recession, the demand for loans is low, and interest rates tend to decline. Rates will eventually start heading higher; they can’t stay at historical lows forever. What can investors expect when this does start to take shape? By analyzing historical bond price and yield data, it might not bode well for fixed-income investors. Although the bond market has historically been less volatile than the stock market, bonds also fluctuate in price. The second image illustrates the inverse relationship between bond prices and bond yields, or interest rates. When yields for new bonds fall, existing bonds with higher

yields become more valuable and can demand a higher price. When yields for new bonds rise, the prices of existing bonds fall to compete with the increased demand for new bonds. If history serves as a guide, when rates start to move upward, bond investors will suffer. One final point: Bond yields, especially long-term bond yields, are sensitive to inflation expectations because inflation can erode the value of a bond over time. If inflation expectations are high, lenders require a higher interest rate to lend funds for more than the short term. Therefore, if inflation expectations remain high, long-term interest rates may take longer to drop, even during periods when the Fed is cutting rates.

Bond Investors Beware of Rising Rates
According to Morningstar research and communications manager Jim Licato, current interest rates are at historical lows in an effort to stimulate consumer spending. The first image below illustrates the rates of bonds with varying maturities (high and low ranges, average, and current) and the federal funds rate since July 1954. Like stocks, the bond market is also affected by the state of the economy. The interest rates on

Five Hidden Fund Gems
Russel Kinnel, director of mutual fund research with Morningstar, compiled a list of five funds whose quality is obscured by past failures:

History of Interest Rates: July 1954–December 2009
High 20 15 10 5.60 5 US 1 Year Yld US IT Gvt Yld US LT Gvt Yld Fed Funds 6.17 6.64 5.52 Low Average Current

Harbor International Growth HAIGX is a strong choice for an aggressive foreign fund, but it’s easy to miss it given its weak 10-year numbers. MFS Growth MFEGX has enjoyed a nice turnaround. Its 10-year loss of 3.9% annualized is lousy, but it has five-year returns of an annualized 4.1%, which is top-quintile. TCW Small Cap Growth TGSCX had a terrible start to the decade. But since Husam Nazer took over in 2005, the fund has gained 52%. T. Rowe Price Global Stock PRGSX manager Rob Gensler’s growth style hasn’t looked all that great in a world-stock category that includes 1.40 14 value and blend styles. Even so, the fund is still ahead of its peer group since Gensler took over.
10 1.00

Relationship Between Bond Prices and Yields: 1926–2009
Bond yields (%) $1.60 1.20 0.80 0.40 1926 1936 1946 1956 1966 1976 1986 1996 2006 Bond prices ($) 16% 12 8 4

Morgan Stanley Mid Cap Growth DGRAX 0.60 6 manager Dennis Lynch has put up strong numbers since he came on board in 2002, but 0.20 the 2 fund’s 10-year numbers are unimpressive.

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Morningstar Advisor - April/May 2010

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