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18 Standout Bond Funds

Here are some of Morningstar's favorite funds across high- and low-quality, U.S. and foreign, and taxable and tax-free categories.

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Note: This article is part of Morningstar's November 2015 Income Investing Week special report. 

Knowing you need bond funds in your income arsenal is one thing; knowing what kind of bond funds you need is another.

The "right" type of bond fund or funds for you comes down to personal preferences. Do you want to stick with the highest-quality bonds you can find, or are you willing to delve into lower-quality bonds in exchange for higher yield? Will you forgo the incremental yield and diversification benefits that high-quality long-term bond funds offer for some protection against rising interest rates? Will you dabble in world bonds for yield pickup--and if yes, do you want currencies in the mix? And does your tax situation make municipal-bond funds attractive?

Two articles can help you figure out what trade-offs you're willing to make in your search for income: "A Checklist for Taxable-Bond-Fund Investors" and "A Checklist for Muni Bond Investors."

Once you have a sense of what you're looking for--and if you already have a bond portfolio, what you may be missing--limit your fund search to the groups that meet your criteria. Morningstar has sliced and diced the bond-fund landscape into a handful of manageable asset classes, listed below. Within each, we list some of Morningstar's favorite funds to get you started.

Domestic Taxable-Bond Funds
Funds landing in the long-term, intermediate-term, short-term, and ultrashort bond Morningstar Categories cluster here. The funds blend government bonds, asset-backed or mortgage-backed securities, investment-grade and high-yield debt, and a modest dose of foreign bonds. Although some offerings are more income-oriented or more opportunistic than others, most provide decent exposure to a variety of bond types.

Two of Morningstar's favorites in this crowd are Dodge & Cox Income (DODIX) and  Fidelity Total Bond (FTBFX). Both funds earn Morningstar Analyst Ratings of Gold and positive scores for all Morningstar Pillars. (As a reminder, funds that earn Analyst Ratings of Gold are expected to outperform their categories and their benchmarks over a full market cycle.)

"A veteran and well-resourced team, time-tested process, low expenses, and an impressive long-term track record earn Dodge & Cox Income a Morningstar Analyst Rating of Gold," says senior analyst Cara Esser. The managers invest with a three- to five-year time horizon, seeking to outperform the Barclays U.S. Aggregate Bond Index while minimizing the risk of loss. Turnover is low, yield generally exceeds those of its peers and benchmark, and duration tends to be shorter than the index.

Meanwhile, Fidelity Total Bond earns its Gold rating due to its low fees and consistently strong risk-adjusted returns. The managers don't make significant duration bets, but they do make active sector bets--usually contrarian in nature. As such, the fund can carry larger weightings in lower-quality and emerging-markets bonds than other funds in its category. Nevertheless, it has delivered over the long term.

Premium Members can access a complete list of Morningstar Medalist funds in this category here.

Vanguard Total Bond Market ETF (BND) is a top choice among ETFs. "The fund offers core fixed-income exposure at a very low cost," notes strategist John Gabriel. In fact, with an expense ratio of just 0.07%, the fund is one of the cheapest bond ETFs around. The fund tracks the Barclays U.S. Aggregate Float Adjusted Index, which includes a mix of mortgage-backed securities, Treasuries, and corporate bonds. That benchmark includes neither high-yield nor foreign bonds, though. "This fund isn't a one-stop shop for comprehensive fixed-income exposure," adds Gabriel.

Despite some turmoil, PIMCO Total Return Active ETF (BOND) is also a pick. "The new three-manager investment team of PIMCO veterans Scott Mather, Mark Kiesel, and Mihir Worah is off to a solid start," says Bush. The ETF is run in a style similar to that of mutual fund PIMCO Total Return (PTTAX), combining PIMCO's macroeconomic views with security selection. "That said, the ETF is a much smaller portfolio than PIMCO Total Return, and differences in cash flows can result in differences in portfolio positioning and performance," reminds Bush.

Flexible Bond Funds
The multisector and non-traditional-bond fund set lands here. Like domestic taxable-bond funds, flexible bond funds can invest across a mix of bond types. Unlike domestic taxable-bond funds, flexible bond funds invest more aggressively in lower-quality paper and/or international debt. And non-traditional-bond funds, in particular, enjoy a high degree of interest-rate flexibility and may employ shorting. Simply put, these are the least-constrained bond funds.

The only mutual fund in this group to earn a Morningstar Analyst Rating of Gold is  Loomis Sayles Bond (LSBDX). "This fund courts plenty of credit, currency, and even equity risk, but it has earned a topnotch long-term record," notes director of fixed income Sarah Bush. Management takes a credit-intensive, often contrarian approach to the bond market. As a result, the fund demands patience from investors, as its returns don't often mimic those of its index nor its peers. "All in all, its experienced, well-resourced team has made good use of its flexible mandate, supporting the fund's Morningstar Analyst Rating of Gold," she says.

Premium Members can access a complete list of Morningstar Medalist funds in this group here.

Government-Bond Funds
The highest-quality taxable-bond funds reside in this group. To be included in one of Morningstar's U.S. government-bond categories, a fund must keep at least 90% of its assets tucked in government securities. Funds that invest strictly in Treasuries, strictly in mortgage-backed securities, or in some combination of the two populate the group. There are three government-focused Morningstar Categories included here, broken down by duration: short government, intermediate government, and long government.

Among this group, Fidelity Government Income (FGOVX) is a favorite, earning a Morningstar Analyst Rating of Gold and positive scores across all five Morningstar Pillars. The fund doesn't get fancy: It sticks with Treasuries and mortgage-backed securities, and doesn't make significant duration bets. Instead, management looks for pockets of value within the government-bond market, tapping into Fidelity's deep qualitative and quantitative tools. Bush warns, however, that like other government-focused funds, this fund is vulnerable to losses when interest rates rise: For example, the fund lost 2.6% in 2013, when rates ticked up. "However, high-quality bond funds can also provide valuable diversification in otherwise equity-heavy portfolios, and this fund more than earned its keep when equity markets turned stormy in 2008 and 2011," she notes.

Premium Members can access a complete list of Morningstar Medalist funds in this group here.

Corporate-Credit Funds
These funds favor bonds issued by corporations. Morningstar Categories in this group include corporate-bond funds, high-yield bond funds, and bank-loan funds. Corporate-bond funds focus on bonds rated investment-grade; these funds, therefore, exhibit some degree of interest-rate sensitivity. High-yield bond funds target bonds rated below investment-grade; these funds invite more credit risk than interest-rate risk. Finally, bank-loan funds also invest in securities rated below investment-grade, and their interest payments are periodically reset. Due to their floating rates, bank loans have limited sensitivity to interest-rate movements.

A favorite here is Fidelity High Income (SPHIX). The fund earns its Gold rating through modest expenses and management's long tenure, a sizable credit staff, and thoughtful bond-picking expertise. "Manager Fred Hoff has distinguished himself over the long haul, faring particularly well through the 2008 credit crisis and its aftermath," says Bush. "Hoff also sidestepped the worst of the high-yield market's late 2014 sell-off, thanks to a significant underweighting to energy and coal names hit hard as oil prices plummeted." Indeed, Hoff is one of the high-yield category's more moderate managers, though he has dipped into lower-quality credits when he feels conditions warrant. That restraint has allowed the fund to perform well during volatile periods, though it can limit the fund when risk-taking is de rigeur.

Premium Members can access a complete list of Morningstar Medalist funds in this group here.

On the ETF front, iShares iBoxx $ Investment Grade Corporate Bond (LQD) is an analyst favorite. "The fund is, far and away, the largest and most-liquid corporate-bond ETF," says Gabriel. The fund tracks the Markit iBoxx USD Liquid Investment Grade Index, which measures the investment-grade, U.S. dollar-denominated, fixed-rate, taxable corporate-bond market. The fund carries an expense ratio of 0.15%, which is below the ETF corporate-bond Morningstar Category average. And during the trailing three- and five-year period, the fund has trailed its index by only its expense ratio.

World and Emerging-Markets Bond Funds
The funds in this group home in on fixed-income securities issued by governments and corporations outside of the United States. That's about the only thing they all have in common. World-bond funds, in particular, must invest at minimum 40% of their assets in non-U.S. debt, but some exclude U.S. debt entirely, or focus on corporates rather than governments, or hedge currencies--or don't. Emerging-markets debt funds, meanwhile, keep at least 65% of their assets in developing-markets debt; but here, too, there are significant variations in currency strategies.

Templeton Global Bond (TPINX) earns a Morningstar Analyst Rating of Gold. "Manager Michael Hasenstab's investment themes and ability to find the right bargains have led to topnotch long-term performance," notes senior analyst Karin Anderson. "His experience, a skilled and generally stable analyst bench, the fund's consistent approach, and attractive fees earn this fund a Morningstar Analyst Rating of Gold." Moreso than his peers, Hasenstab has preferred emerging-markets debt and currencies, and currently maintains one of the more modest durations in the world-bond category.

Premium Members can access a complete list of Morningstar Medalist funds in this group here.

Inflation-Protected Bond Funds
As their names suggest, inflation-protected bond funds seek to protect investors from rising inflation. As such, these funds invest in securities whose principal values adjust along with the rate of inflation. However, these funds aren't impervious to changes in interest rates: They will likely suffer if rates rise for a reason other than rising inflation.

Morningstar's favorite here is Gold-rated Vanguard Inflation-Protected Securities (VAIPX). "Manager Gemma Wright-Casparius employs a straightforward approach that sticks strictly to Treasury Inflation-Protected Securities, unlike some peers in the inflation-protected bond Morningstar Category that regularly employ other instruments like mortgage-backed securities, emerging-markets debt, or even corporate bonds," says analyst Kiran Lalani. This straightforward approach and low expenses have given the fund a performance edge over time, and contribute to its Gold rating.

Premium Members can access a complete list of Morningstar Medalist funds in this group here.

Among ETFs, Schwab US TIPS ETF (SCHP) provides low-cost access to these inflation hedges. The fund tracks the Barclays U.S. Treasury Inflation-Protected Securities Index (Series-L), which includes all TIPS issued that have at least one year left until maturity and $250 million in par value.

Municipal-Bond Funds
Interest earned on muni bonds is generally free from federal income tax and may even be exempt from state and local taxes, depending on where you live. An array of tax-free fund categories makes up this group. Some funds invest in shorter-, intermediate-, or long-term munis. Some focus on high-quality credits, while others focus on high yield. Some are even dedicated to investing in credits from particular states.

Six muni funds receive Morningstar Analyst Ratings of Gold. Four of those funds are managed by Fidelity: Fidelity Limited Term Municipal Income (FSTFX), Fidelity Intermediate Municipal Income (FLTMX), Fidelity Municipal Income (FHIGX), and  Fidelity Tax-Free Bond (FTABX).

"All of these funds take a relatively cautious approach that offers solid downside protection in rocky municipal-bond markets," says senior analyst Elizabeth Foos. The teams take a research-intensive approach, tapping into Fidelity's deep bench of muni-bond analysts and dedicated traders. The teams avoid interest-rate bets and instead tend to keep their durations close to their respective indexes. That said, they are willing to make some yield-curve plays, when opportunities arise. The main differences among these five funds is duration. In addition, while Municipal Income and Tax-Free Bond both invest in long-term securities, Tax-Free does not buy bonds subject to the Alternative Minimum Tax (AMT). "The combination of solid long-term records, experienced teams, and ultralow expenses earns them each a Morningstar Analyst Rating of Gold," she says.

T. Rowe Price oversees the other two Gold-rated muni funds: T. Rowe Price Summit Municipal Intermediate (PRSMX) and T. Rowe Price Tax-Free High Yield (PRFHX).

Summit Municipal Intermediate manager Charlie Hill avoids riskier pockets of the muni market. "Although he'll look for value along the yield curve, Hill doesn't make big interest-rate bets either," adds Foos. Hill will, however, make sector and security plays. "A sound strategy, experienced manager team, and focus on research and quantitative analytics should serve investors well, earning the fund a Morningstar Analyst Rating of Gold."

Tax-Free High Yield is the only muni fund focusing on lower-quality credits that earns a Gold rating. Although he targets higher-yielding issues, manager Jim Murphy is cautious: He limits the fund's exposure to leveraged structures and avoids the market's riskiest names. Murphy also has the luxury of tapping into T. Rowe Price's experienced muni-bond research and quantitative teams. "Over time, the research and restraint combination has helped blunt the high-yield muni market's sharper edges, while providing superior long-term returns," says Foos.

Premium Members can access a complete list of Morningstar Medalist funds in this group here.

iShares National AMT-Free Muni Bond (MUB) makes for a solid muni choice in the ETF space. "This is the largest and most-liquid municipal-bond ETF," says Foos. The fund tracks the S&P National AMT-Free Municipal Bond Index, which measures the U.S. investment-grade tax-exempt muni market. It excludes bonds subject to the AMT and those issued in U.S. territories, including Puerto Rico. "The fund weights its holdings by market capitalization, which means that the most heavily indebted municipal issuers receive the largest weightings in the portfolio," warns Foos. Issuers with the heaviest debt burdens, like California and New York, may be more susceptible to ratings downgrades. "However, the fund's focus on investment-grade bonds helps mitigate credit risk," she adds.

Are you looking for tips on improving your portfolio? As part of Morningstar.com's Portfolio Makeover Week in December, director of personal finance Christine Benz will be making over five real-life portfolios to show how investors of all stripes may streamline and upgrade their holdings. To be considered for a makeover, submit a request to portfoliomakeover@morningstar.com. Include a general description of your situation, including portfolio size, as well as your goals for the makeover. We will alert you if we decide to feature your portfolio on the site and will remove any personally identifying information in any published material.

Susan Dziubinski does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.