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How to Choose a Short-Term Bond Fund

Here are three recommendations that fit the bill by focusing on liquidity, diversification, and thorough risk management.

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Emory Zink: Investors in short-term bond funds are typically seeking safety and have a low tolerance for losses. Shrewd offerings deliver on this goal by focusing on liquidity, diversification, and thorough risk management. Interest-rate calls are difficult to get right, so you want to invest with a manager that has a disciplined approach to limiting the fund's interest-rate sensitivity. Managers that are taking more liquidity or credit risk could expose investors to volatility, which may lead to outflows that exacerbate liquidity troubles, as we saw during the financial crisis.

A few of our recommendations in the short-term bond Morningstar Category, which take these concerns into consideration, include Baird Short-Term Bond, which earns a Gold rating on its cheapest share classes. This strategy is guided by an experienced team that stays within its guardrails. The fund is run duration-neutral to its Bloomberg Barclays 1-3 Year Index benchmark, but the team has historically added value through thoughtful portfolio construction. Holdings are diversified across numerous names and sectors. In 2019, half of the fund's portfolio was parked in corporate credit, a third in U.S. Treasuries, and the remainder in asset-backed securities, mortgage-backed securities, and cash. The team doesn't shy away from BBB rated fare, either, but has exhibited good judgment with those selections historically.

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