WHEN SHOULD YOU BUY a bond, when should you buy a bond fund?

That’s a complicated question about which volumes could be written, but fortunately there is a fairly simple answer available.

First let’s define the dilemma. The two important variables as you go about deciding whether to own bonds directly or indirectly are these: annual holding costs and liquidity.
Your annual holding cost is the percentage fee you incur to stay put in an investment. Liquidity is your ability to buy and sell with minimal transaction costs (commissions and sales charges) and minimal inconvenience.
There is, naturally, a tradeoff. An investment with a low annual holding cost is unlikely to offer the best in liquidity. Conversely, if you go for maximum liquidity you are inevitably going to pay some holding costs.

Penny Stock Funds

Example: You have $300,000 you want to put in municipal bonds. A muni bond fund from Vanguard has perfect liquidity: You can buy and sell with a phone call and there’s no fee or markup. But the annual holding cost is $600, in the form of a 0.2% fund expense ratio.

Alternative: Buy twelve $25,000 muni bonds yourself in a Charles Schwab discount brokerage account. The annual holding cost is $0. But the liquidity is terrible. You could run up a tab of $1,500 to $3,000 (in the form of hidden bid/ask spreads) to assemble the portfolio, and God forbid you need to cash in any of the bonds early. You’d have to pay those bid/ask spreads all over again.

US Treasury Bonds

Now here’s our formula. If you are buying U.S. Treasurys, stick with a no-load fund if you have less than $50,000; if you’re buying municipal bonds, stick with the fund up to $500,000; if you’re buying junk, foreign or exotic bonds, stick with the fund up to $5 million.
You can modify the break points in this rule of thumb to suit your own purposes. Here’s why we chose the numbers we did.

A portfolio of Treasurys can be economically assembled on your own even if it’s fairly small. That’s partly because diversification is unnecessary. Unlike other issuers, the U.S. government is default-proof. So you can safely put your entire wad into one issue. That keeps your transaction costs down.

Also, Treasurys are highly liquid. Because there are a lot of them outstanding and they are traded every day in huge volumes, their bid/ask spreads are narrow–often less than 1% even on a tiny $50,000 order.
You can get your costs still lower on a Treasury purchase by buying at a government auction. Schwab will handle the paperwork for $49.
If you’re really cheap, you can avoid even this $49 fee by dealing directly with a Federal Reserve bank. (We don’t recommend this method unless you are highly confident of holding the bond to maturity. Selling a bond held in a Fed account is slow and painful.) For more information on the Treasury Direct program, call the Bureau of the Public Debt in Washington at 202-874-4000.

Tax-exempt bonds are a little trickier

Diversification is definitely a matter of concern. As the bankruptcy of Orange County, Calif. aptly demonstrated, it’s a good idea to buy from some 20 issuers to hedge your bets. Bid/ask spreads are significantly wider than on Treasurys, and all but unaffordable on lots smaller than $25,000. That’s why we recommend a $500,000 minimum for a portfolio of individual bonds.

But lower this hurdle if any of the following apply:
You buy the munis at original issue, paying the same price as institutional investors and thus minimizing the transaction cost at purchase.
You intend to hold every bond to maturity, eliminating the transaction cost at the other end.

You buy only insured or AAA bonds, which are more liquid.
As for junk and exotic bonds, steer clear of do-it-yourself money management unless you are really in the big leagues. Bid/ask spreads, even for institutional-size trades, can be 5%. Default risk is high. Subtleties in the bond indenture may catch you unaware. You may need a computer to know whether the price quoted to you is even close to the fair value of the bond.

Have we persuaded you to put your fixed-income money in a fund? Then watch your costs. Don’t pay a sales load. Don’t pay more than 0.5% a year in expenses for a municipal or a high-grade taxable bond fund. You might go as high as 1.2% for a junk fund with an excellent performance record. See the table for Forbes’ Best Buys in bond funds.



Nielsen Investment Ratings

EARLIER THIS YEAR Alan Segal, a creative director at ad agency Saatchi & Saatchi, wanted to know how much business his client, Toyota, was getting off its Web site. The Web site reported 7,000 “page views,” which meant Toyota’s cost of running advertising was 19 cents per view. That seemed too high to Segal, so he complained to the site.

The next month, the number of reported “views” miraculously doubled, basically halving Segal’s per-viewer ad costs. “We decided we needed a third party tracking viewers,” he says.
Only 900 Web sites (out of 400,000 total) carry advertising, and they’re chasing $300 million worth—small change when compared to the more than $45 billion spent last year on television ads. But in the next four years, ad spending on the net could mushroom to $5 billion.
Standing in the way of that growth has been the lack of a credible way to measure what advertisers are getting.
Cost per thousand views ranges from about $9 to over $150. Some of that variation is due to different demographics—some Web sites cater to specific high-income groups while others seek out broader audiences. But much of the cost-per-thousand gap is due to sheer confusion: How can you reliably measure how many people notice your message? International Business Machines and Procter & Gamble, two of the world’s biggest advertisers, say they won’t advertise on any site that isn’t audited by a third party.
Such auditing is thus the next logical step in the evolution of the new advertising vehicle. The traditional advertising media already have such a service. In radio, it’s Arbitron. Magazines and newspapers have the Audit Bureau of Circulations. TV utilizes ratings provided by NielsenMedia Research, whose parent company last year raked in revenues of $1.5 billion.
Who will provide the Nielsen ratings of the Net? Not surprisingly, Nielsen wants to. Last year it bought an estimated 10% stake in a San Francisco, Calif. outfit called Internet Profiles or I/Pro, which polls the most popular Web sites and tallies the sites’ raw data of views every month.

The Nielsen name gave I/Pro instant credibility, which translated into market share. It now measures viewing activity on close to 85% of the most-visited sites. Among its clients are sites such as Netscape and search engines Yahoo and Infoseek.

But the contest isn’t over. I/Pro relies on the sites themselves to provide the raw data. So it is not really a third-party reporter. It is very easy to fake hits on the Web. Any Web operator, for instance, can easily rig up a robot program to visit the site from elsewhere on the Web, generating thousands of fictitious hits. Critics say I/Pro may be a third party, but its tallies aren’t necessarily any more reliable. “A lot of people are looking for a better mousetrap,” says Fred Axelrod, an analyst with Western Media, North America’s largest media buying organization.
The better mousetrap may be NetCount, founded by 29-year-old Paul Grand and run out of a basement at the grungy corner of Hollywood and Vine in Los Angeles.
Grand was designing Web sites for Hollywood studios, but his struggle for reluctant advertising dollars convinced him that the real opportunity lay in measuring the number of people hitting his sites. So he developed software that could be installed onto Web sites to count views independently of the operator.
Grand’s software monitors all the activity on the Web site and relays it back to high-powered computers in NetCount’s offices. So there is no opportunity to fudge numbers, and NetCount gets a head start on processing the data. Netcount distributes its ratings to clients daily via computer, instead of monthly by mail as I/Pro does.” I know I/Pro has a lead, but I also know it’s surmountable,” says Grand.
NetCount will do more than just log viewers. Grand plans a service that provides demographic data on the viewers behind the hits. It learns what sites the viewer has been to and where he goes from there.

“I’m astounded at the amount of information we are gathering,” says Saatchi’s Segal, who says NetCount picked out particularly high viewership on the Toyota site through America Online. Toyota is now developing ways to reach those users. Grand has also signed clients like Lycos and MSNBC.
For its part, I/Pro mocks NetCount. “It’s like Apple saying it has targeted Intel,” says Mark Ashida, I/Pro’s chief executive. Maybe, but remember what the Bible saith about pride going before a fall.

Mutual Fund Families

Years back, it made sense to mix and match mutual funds from different sponsors to build a portfolio. A decade ago Fidelity had no Ginnie Mae fund, no insured municipal bond fund and only one international fund. Vanguard had no Treasury funds and no California muni funds.

Even to assemble a portfolio of six funds, an investor might have had to buy from at least four fund companies, large and small. Result: a blizzard of paperwork, account statements with different reporting dates, tax documents that come in different formats at divergent times. In short, a mess that only an accountant could love.
It’s time to simplify your mutual fund life. Today you can do much of your fund shopping under one roof–or two. There’s still room for boutique funds from smaller, more specialized sponsors, but the bulk of your fund investments should be centralized for simplicity.
The five fund families profiled (See articles on Capital Research, Fidelity Investments, T. Rowe Price, Charles Schwab and Vanguard) offer a broad selection of funds with admirably successful long-term results and acceptable holding costs. In limiting the number of funds you own to a half-dozen or so, as we advise in the article “Enough already”, you should be able to find most of what you need at one or two families.

Our five featured fund families are a good starting place. With the exclusion of Schwab, which does not actively manage stock portfolios, these families have respectable records as stock pickers (See table “The best stock pickers”). More important, in our view, is that they offer a depth of investment choices at reasonable cost.

One of our families, the American Funds run by Capital Research & Management Co. of Los Angeles, is the best example that we know of to illustrate the virtues of moderation in investing. Despite their lack of superstar managers or hot performers, these funds are leaders over the long term.
When buying funds, don’t confuse short-term success with long-term durability. On July 6, 1995 the Strong American Utilities Fund ran an advertisement in the Wall Street Journal. “America’s #1 Utility Fund,” it boasted. Two weeks later Dreyfus advertised its Edison Electric Index Fund in the same paper. “The #1 Utility Fund,” bragged the Dreyfus advertisement.
Who was right? Both–and neither. The Strong was tops among 72 utility funds tracked by Lipper Analytical Services for the year ended Mar. 31, 1995. The Dreyfus fund had that honor among 75 utility funds in the year ended June 30, 1995. So the ads were true, so far as they went.

But during the 12 one-year periods that ended between July 1994 and June 1995, five different utility funds got to be number one at least once. Far from being some rare honor that brands a single fund as the best, being number one for the short term is no big deal. Indeed, the Dreyfus fund has a rather dubious claim on any championship. This supposed winner spent much of the past year in the dankest parts of the cellar; in 2 of the 12 periods, it was dead last among at least 50 peers (See table “Don’t blink or you’ll miss it”). No surprise it did not advertise its performance then.

Be warned, then: Short-term results are shockingly poor predictors of long-term performance. So are performance numbers considered in a risk vacuum. The past five years have been unusually bullish, with a 12% annual gain for the market (dividends reinvested). In such an environment, the “top” funds are the ones that took the biggest risks–by using leverage or buying growth stocks trading at steep multiples of their earnings. These are just the funds that will do the worst in a bear market, but if you pick your investments by looking at lists of “Top funds, past five years” you won’t find this out until it’s too late.
To help you sort out the confusing claims about performance, Forbes rates stock funds over three full market cycles, going back to June 1983, and we grade separately for bull and bear markets. The bear market grade is the most important measure of risk.

Unless you are highly confident that the bull market will continue for the next five years, avoid funds that do badly in bear markets. In all your fund investing, but especially in buying bond funds, pay attention to costs.
So far in 1995, the market is up 22%–returning more by this point in the year than it has in all but 5 of the past 15 complete years. This is just the time when you may be tempted to veer off on a chase after hot performance, regardless of cost or risk. We hope this guide will put you back on course.

Bonded Motors IPO

BONDED MOTORS’ headquarters and factory building in South Central Los Angeles doesn’t draw many investment bankers. South Central spawned Los Angeles’ 1992 riots. Bonded Motors’ fences are topped with razor wire. Broken-down cars dot the streets. Groups of unemployed men loiter nearby.

But in April Bonded Motors Inc. went public. As part of their due diligence, a handful of nervous bankers had to visit the company’s place of business. What they saw was grimy and low-tech. Bonded Motors’ business is remanufacturing car and light truck engines. Workers take the metal cores of broken engines, retool worn surfaces and then refit them with new pistons and other parts. Oil frequently splatters on visitors. Some of the investment bankers, says Aaron Landon, Bonded’s founder and chief executive, “weren’t too happy with what happened to their $500 shoes.”
It’s not pretty, but it is profitable. Bonded Motors sold $13 million worth of remanufactured engines last year and netted $1.3 million (65 cents a share), 20% more than it made the year before. In April Commonwealth Associates, a small New York underwriter with a few blemishes on its record, managed to sell one-third of the company to the public for $5.9 million, with all proceeds being added to Bonded’s capital. The new shares are up slightly from the 5 7/8 offering price, to a recent 7 1/4.
How can a company in the heart of the inner city turn in such solid numbers? Landon’s reply: By using what the inner city has to offer.

South Central has plenty of old cars, and old car engines are Bonded Motors’ raw material. Lots of local moonlighters cruise nearby junkyards for engines, then show up at Bonded looking to resell them. Most businesses wouldn’t like having men who are covered in engine grease and drive beat-up pickup trucks hanging around the shop. Landon loves them: They are his best suppliers. He picks up used engines from them for half of what he pays organized resellers.

Are some of the engines filched? It’s impossible to tell with most old engines, and Landon doesn’t ask too many questions.
Landon likes the neighborhood’s labor force, too. Bred on southern California’s car culture, many of Bonded’s employees have been retooling old engines since they were teenagers. Noting that the area’s unemployment rate is nearly 17%, Bonded’s chief financial officer, Paul Sullivan, says: “We have a very, very dedicated work force who respect a good job when they see it.” Turnover among Bonded Motors’ 220 employees is under 3%, and firing for cause is rare. There is no need to advertise job openings; word-of-mouth brings in five qualified applicants for every new spot.
Hiring locally has another advantage: South Central Los Angeles is part of a state “revitalization zone,” which qualifies Bonded for tax credits for each new neighborhood hire. This year Landon expects his company to get nearly $600,000 in state tax credits, much more than it can use. With California’s onerous 9.3% corporate tax rate, the credits add about 6% to Bonded’s bottom line every year.
A testament to the power of lower taxes as a cure for inner-city unemployment? You bet. The extra money has helped fund expansion of Bonded’s factory into nearby buildings and has increased the company’s distribution reach.
What’s more, if Bonded had to pay the same tax rate as it would have to in the suburbs, its aftertax profit margins might not have impressed investors enough to let it go public in the first place.

Landon expects even more tax help from federal credits aimed at moving people off the government dole. With the large number of welfare recipients in its labor pool, the company figures that its effective federal tax rate could drop from 34% to 28% next year.

There is more to Bonded’s success than just its inner-city location. Much of the company’s growth is fueled by the rapid consolidation in the retail auto parts market (Forbes, Mar. 11). Big stores such as AutoZone and Pep Boys (Manny, Moe & Jack) are chasing small-fries out of business. These big chains want bigger suppliers, like Bonded.
Landon, 54, has been rebuilding engines since he was in high school. Fresh out of the nearby University of Southern California with an undergraduate business degree in 1964, Landon took a $150,000 loan to start a small rebuild shop.
For the next 20 years he was much like the small engine-remanufacturers that still dot South Central, selling to local garages. But Landon was one of the few to bet big on retail consolidation. Now four large chains account for 72% of his company’s sales.
While the retail market has consolidated, the $3 billion engine-remanufacturing business remains fragmented. Landon is looking to acquire, which is one reason he raised public money in April, and may soon raise some more.
A secondary offering should be easier than the first. Landon couldn’t get a single appointment in Los Angeles for the IPO road show, which he blames on South Central’s bad image. Most of the original investors were found on the East Coast. “There was neither sympathy nor compassion,” says Paul Sullivan of potential investors’ response to the company’s promise of providing jobs in the inner city. “But they did like the numbers.