All-Weather Bond Funds
Their moderate approaches will be a boon after interest rates bottom out.
The Federal Reserve has slashed interest rates by more than 2 percentage points since September 2007 in order to juice the floundering U.S. economy, and there may be more cuts on the way. These moves might prompt some bond-fund investors to seek offerings with longer duration (a measure of a bond's sensitivity to interest-rate changes). Funds with long-duration bonds tend to hold up better when interest rates drop and are left worse off when they rise.
A better approach, however, would be to invest with an all-weather offering that won't be left flat-footed when the economy recovers and interest rates tick up again.
We decided to zero in on intermediate-term bond funds, which, not surprisingly, fall somewhere in between short-duration funds, which assume the least amount of interest-rate risk, and more risky long-duration bond funds. In order to find strategies that take on less interest-rate risk, we selected funds with below-average duration. We also looked for funds with high credit quality--a portfolio average of AA or better--to steer away from funds that take on significant credit risk.
Finally, we included three more basic criteria--below-average expenses, managers with five years or more at the helm, and above-average five-year returns--to get to some of our favorites as well as some lesser-known funds.
As of Feb. 11, 2008, plugging these criteria into the Premium Fund Screener yielded these 12 intermediate-term bond funds:
American Funds Bond Fund of America (ABNDX)
Baird Aggregate Bond (BAGIX)
Dodge & Cox Income (DODIX)
Federated Total Return Bond (FTRBX)
FPA New Income (FPNIX)
JPMorgan Core Bond Select (WOBDX)
Julius Baer Total Return Bond (BJBGX)
Metropolitan West Total Return Bond (MWTRX)
RiverSource Diversified Bond (INBNX)
Robeco WPG Core Bond (WPGCX)
T. Rowe Price New Income (PRCIX)
Vanguard Total Bond Market Index (VBMFX)
One of our favorites on this list is Baird Aggregate Bond (BAGIX). Manager Mary Ellen Stanek avoids taking on interest-rate risk because she doesn't think it's an efficient way to add value. Thus, she sets the fund's duration equal to that of the Lehman Brothers U.S. Aggregate Index, the category's standard benchmark. She was also wary of trouble in the mortgage markets and started trimming mortgage-backed securities and financials exposure in late 2006. Stanek also keeps the fund's risk in check by rotating the fund's sector allocations and hunting for undervalued securities to boost returns. A bargain price tag gives it even more appeal.
It's worth noting that not all funds on the list intentionally snuff out interest-rate risk. Take Metropolitan West Total Return Bond (MWTRX), for example. Managers Stephen Kane, Laird Landmann, Tad Rivelle, and David Lippman--Morningstar's Fixed Income Managers of the Year in 2005--take on some interest rate and credit risk as an integral part of their strategy. But the key is they know when to take those risks. They set the fund's duration slightly short of the Lehman Brothers Aggregate Index in early 2007, which helped as interest rates stayed higher. From the second quarter throughout the rest of the year, they stayed conservative on interest-rate risk by keeping duration on par with the bogy. In 2007, their anticipation of the problems stemming from the weak housing market was key. They reined in credit risk by selling corporate bonds in favor of government-related issues, which helped keep it ahead of most rivals.
Morningstar.com Premium Members can run this screen themselves by clicking here. Not a Premium Member? You can still run this screen by taking a free, 14-day Premium Membership trial. (Note that the results may change as funds come in or drop out of the screen over time.)
Karin Anderson has a position in the following securities mentioned above: DODIX. Find out about Morningstar’s editorial policies.