October funds: Beware rising rates

If you want to know what will happen to your mutual funds if interest rates rise, September's winners could give you a good preview of funds that could fare well in October.

Short-term interest rates are controlled by the Federal Reserve, and there's little chance the Fed will bump rates higher in October. Most economists don't think the economy will be growing fast enough for the Fed to hike rates until the first quarter of 2015.

But long-term interest rates are set by the bond market, and the Fed will have exited its bond-buying program, called quantitative easing, this month. If the economy continues to grow, interest rates should rise.

And, in fact, long-term rates have been rising since the end of August, when the bellwether 10-year Treasury note yield hit 2.34%. It is just above 2.50% now. So which funds did best?

Among stock funds, the best-performing funds were ones you probably shouldn't buy: bear-market funds, which rose an average 5.7%, vs. a 0.9% fall in the Standard and Poor's 500-stock index. Bear funds are designed to rise when the stock market falls — which it often does when interest rates first start to rise.

But predicting the start of a bear market is just as hard as calling the end of one, and most investors have no business in bear funds — particularly those that use futures and options to add rocket fuel to their returns. If you must choose one, consider one that relies on something other than jet fuel to ward off the bears — like GAMCO Mathers (MATRX), which at least holds a healthy slug of cash along with its short positions.

Managed futures funds can also help alleviate a stock decline, in part because they don't rise or fall in lockstep with stocks. The funds rose an average 1.6% in September. But these funds typically have high ongoing costs, which will always work against you. The best of the lot: Natixis ASG Managed Futures Strategy Fund (ASFYX), up 0.6% last month and 11.8% this year.

And rising rates or not, high-growth areas tend to attract the stock market's attention, which is why health and biotech funds could continue to do well. Global health and biotech funds rose 1% and 0.6%, respectively, and the sector's earnings remain solid.

What should you avoid?

•Bond funds. Bond prices fall when interest rates rise. Nearly all types of bond funds fell last month, and if interest rates continue to rise, bond funds will keep falling. Bear in mind that the average rate for the 10-year Treasury the past 10 years is 4.4%, so rates could have a long rise in front of them.

•Utility funds. Investors buy utilities for their dividends, and when bond yields rise, they present tough competition for utilities. The funds fell an average 3.5% in September.

•Precious metals funds. Gold tends to go in the opposite direction as the value of the U.S. dollar — and higher rates means that more money goes to U.S. Treasury securities, which are denominated in dollars. The average precious metals fund fell 7.5% in September, and the average gold mining fund plunged 16.8%.