Has Your Bond Fund Been Acting Like One?
Heavy credit or currency risk can make for more equitylike returns.
One of the reasons for owning bond funds is diversification from equities, so we thought we'd look for bond funds that move in sync with stocks.
These funds have their merits, but they offer less diversification than the typical bond fund. U.S. high yield, emerging-markets bonds, and bank loans have been the most highly correlated with the S&P 500 during the past three and five years, so funds that invest in these sectors, even at the periphery, may not offer the stability many investors seek.
Loomis Sayles Bond (LSBRX) and Loomis Sayles Investment Grade Bond's (LGBNX) three-year correlations to the S&P 500 are among the highest in the multisector and intermediate-term bond Morningstar Categories (0.71 and 0.60, respectively) because they sport ample credit and foreign-currency risk and they even own equities. Loomis Sayles Bond can own up to 35% in high yield, 20% in non-U.S. dollar-denominated debt, and 10% in common stock.
Its management team has made full use of those allocations at times, which has caused the fund to lose money when the S&P slides such as 2011's rocky third quarter and in the commodity-driven sell-off from mid-2015 to early 2016. Loomis Sayles Investment Grade Bond can own less than one third as much as its sibling in high yield and common stock, but the team's penchant for bargain-hunting in sell-offs has also caused it to lose money during challenging markets.
Multisector-bond funds T. Rowe Price Spectrum Income (RPSIX) and Fidelity Strategic Income (FSICX) sported 0.66 and 0.61 correlations, respectively, to the S&P 500. T. Rowe Price Spectrum Income is invested across 15 T. Rowe Price bond funds, as well as T. Rowe Price Equity Income (PRFDX). While it tends to hold less high-yield corporate debt than many of its peers, it carries non-U.S. dollar exposure that includes emerging-markets local-currency debt and a bank-loan allocation. Fidelity Strategic Income takes a barbell approach to credit risk. On the gutsy side of the portfolio, it typically aims for 40% in high yield, 15% in emerging-markets debt, and 5% in bank loans, while stashing around 40% in developed-markets government debt to counteract some of that risk. This fund's focus on hard-currency emerging-markets debt means it takes on less foreign-currency risk (hard-currency bonds are denominated in U.S. dollars), but that can increase its credit risk as many of these issuers sport junk ratings.
On a related note, Templeton Global Bond's (TGBAX) emphasis on emerging-markets currencies (roughly two thirds to four fifths of its currency exposure) has caused it to lose money in extreme risk-off periods like 2011's third quarter. The government-bond-focused fund has about a fourth of its portfolio devoted to below-investment-grade sovereigns such as Brazil, Argentina, and Ukraine, which has also contributed to its riskier profile, but its extremely low duration for the past few years (less than one year) has also kept it from acting like a typical bond fund. (Its 0.56 correlation to the S&P remains on the high side of the world-bond category.) This fund experienced its toughest period yet in the recent market slide from mid-2015 to early 2016 as duration rallied and emerging-markets local-currency bonds sank.
These aggressive bond funds are great long-term investments, but they won't provide traditional fixed-income ballast. Instead, consider bond funds that carry more consistent stakes in Treasuries, mortgages (both agencies and nonagencies), and asset-backed securities, all areas that have been negatively correlated to equities over time. Fidelity Intermediate Bond (FTHRX) and Metropolitan West Total Return Bond (MWTRX), both in the intermediate-bond category, certainly fit the bill, with negative 0.06 and negative 0.13 correlations to equities during the past three years. In addition, both have avoided non-U.S. currency exposure and haven't made wild duration calls versus their benchmarks, which has helped them generate a positive return when equity markets sour.
Karin Anderson has a position in the following securities mentioned above: TGBAX. Find out about Morningstar’s editorial policies.