It’s been a tough year for bonds so far. Of course, a tough year for bonds can be a tough day for stocks. But investors seem equally disturbed by a 2% loss in bonds as by a 10% or more loss in stocks, so it’s worth looking at how bond funds have weathered the most recent storm. We looked at some of the most popular funds that reside in Morningstar’s intermediate term bond fund category. That category contains funds whose duration is moderate and whose holdings tend to be almost all investment grade, and so those funds tend to be the workhorses of most investors’ portfolios.
Through May 1, the BloombergBarclays US Aggregate is down 2.42%. That’s a total return number, so it includes the difference in price plus interest payments. The Morningstar intermediate term bond fund category average is down 2.11%, a slightly better showing likely owing to the higher corporate bond exposure and slightly lower duration of many funds compared to the Treasury -heavy index.
First, all of our selected funds have beaten the index so far this year except for the Western Asset Core Bond fund. The fund’s portfolio doesn’t appear unusual, although it has more of its assets in Agency Pass-Throughs than its peers (35% versus 21%), according to Morningstar. It has nearly 22% of its portfolio in Government bonds, according to Morningstar. Almost all of that is in U.S. Treasuries with a small part scattered in U.S. Agencies and Non-U.S. government debt. Nearly 8% of the fund’s portfolio is in emerging markets debt.
However, the fund’s average effective duration, a measure of interest rate risk, is nearly seven years, and that has likely contributed to its underperformance. No other fund’s duration is over seven, and the next highest three are barely over six. Five of the funds have durations around 4 years, and they’ve tended to hold up better this year.
Things Besides Duration Matter Too
Two funds stand out for bucking the trend of duration dictating performance. First, the Delaware Diversified Income Fund clocks in with a duration of 6.09, but the fund has still been able to eke out a gain over the Morningstar intermediate term category average and the Bloomberg Barclays U.S. Aggregate. This fund has traditionally held a lot of corporate bonds, including more high yield bonds than its peers. Currently the fund has 13% of its portfolio in BB-rated bonds (the highest level of junk or high yield), and those have held up better than more highly rated bonds this year. So the fund’s credit risk has likely helped it in an environment when interest rate risk has inflicted more pain.
Second, PIMCO Total Return has the lowest duration of the group at 3.99 years, but has lost more than the category average. The fund has been lighter in corporates than its peers – 19% versus 30%, according to Morningstar. It also has a significant allocation to what it classifies as “US Government Related,” which, according to PIMCO’s website, could include “nominal and inflation-protected Treasuries, Treasury futures and options, agencies, FDIC-guaranteed and government-guaranteed corporate securities, and interest-rate swaps.” Morningstar has its Agency MBS Pass-Through allocation at 39%, relative to 22% for its peer average. The fund’s most recent quarterly commentary mentions that positions in Agency MBS along with short exposure to the Japanese Yen, short exposure to duration in Japan and Canada, and exposure to high yield corporates” detracted from performance. The fund’s most recent monthly commentary lists non-U.S. rate strategies, positions in non-Agency MBS, and high yield corporates as the largest detractors.
It should be said that the new managers of PIMCO Total Return have done quite well since taking over in the fall of 2014. The new management team has been running the fund for a little over three years now, and, after a choppy start, the fund ranks in the 28th percentile of Morningstar’s intermediate term category for the three-year period ending in April 2018. A quarter’s worth of underperformance shouldn’t discourage any investor from choosing a particular fund or manager, though it’s useful to check in on asset classes and particular funds from time to time.