Barron\'s - April 6 2020

L8 BARRON’S•Funds Quarterly April 6, 2020

T

he proverb “hindsight is 20/20” is fitting for the year 2020. Had we

known what we know now, we would have started socially distancing

sooner and tilted our portfolios toward what has been one of the hot-

test investments so far this year—U.S. Treasuries.

The same fears that have driven up prices of hand sanitizer have

sent government bond prices soaring. The average long-term U.S. gov-

ernment bond fund is up 20% this year, according to Morningstar, and

this follows 14% returns in 2019. Pimco Extended Duration (ticker: PEDIX) has

returned 45% over the past 12 months. Yes, you read that right.

But while investors often talk about bonds in broad terms, the past several

weeks have underscored the fact that the global bond market is anything but ho-

mogenous. Of the 19 taxable bond fund categories tracked by Morningstar, all but

four—short-, intermediate-, and long-term U.S. Treasuries, plus intermediate

core—have lost money this year.

So what’s a bond investor to do

now? For most, the best advice is prob-

ably to “shelter in place.” Extreme mar-

kets are generally not the time to make

drastic changes to your portfolio. But if

the past month has been a wake-up call

that your allocations are at odds with

your expectations, or if you’re looking

to bump up your cash cushion, there

are some strategies to employ now.

“You need to ask yourself why you

own bonds in the first place,” says

Todd Rosenbluth, head of exchange-

traded and mutual fund research at

CFRA. A generation ago, the answer

was pretty simple: diversification and

predictable income. In this era of

chronically-low interest rates and mas-

sive volatility, however, investors need

to pick their battles.

But it’s battle-weary investors that

have driven the wide dispersion in the

bond market. “Everyone wants safety,

so today there are Treasuries, and then

everything else,” says Jeff DeMaso,

director of research at Adviser Invest-

ments. Bonds on the riskier end of the

scale were the hardest-hit; high-yield

and emerging market bond funds fell

12.6% and 14.3%, respectively, in the

first quarter, holding up better than the

U.S. stock market. Prices for corporate

bonds fell so much as Treasury prices

were rising that corporate credit

spreads—the difference in yields be-

tween corporate bonds and comparable

Treasuries—reached one of their wid-

est points in 20 years, second only to

the financial crisis.

“There are really good-quality com-

panies whose bonds are selling off,”

says Miriam Sjoblom, director of fixed-

income ratings at Morningstar. “In

most cases, if you have a pretty conser-

vative portfolio, it’s definitely worth

being patient.”

In other words, investors shouldn’t

be quick to judge their bond fund man-

agers based on the essentially no-win

recent scenario. Instead, use this time as

a gut-check—assess the different roles

that bond funds should play in your

portfolio—and rebalance as needed.

Safety Is Your No. 1 Concern

In truth, no investment is without

risk. Yet, when investors talk about

“risk free” bonds, they are referring

to U.S. government bonds, which

carry no credit risk (in theory, at

least) because they are backed by the

U.S. government.

“You want to own [Treasury] bonds

for the simple reason that they are an

What To Do With Your

Bond Portfolio Now

The coronavirus pandemic has changed everything—including how bonds behave.

Investors are in for turbulent times, and how they approach bonds needs to change, too.

“WhydoI

own bonds?

Because I

own stocks.”

Steve Raneri,

GM Advisory

Group

By SARAH MAX

insurance policy against turbulent

times,” says David Rosenberg, chief

economist and strategist of indepen-

dent research firm Rosenberg Re-

search. A longtime bond bull, he says

that he expects global investors to con-

tinue clamoring for safety for the fore-

seeable future.

That safety comes at a price. The

yield of the bellwether 10-year Trea-

sury now sits below 1%, while yields

for one-month and three-month Trea-

sury bills briefly turned negative on

March 26, and now sit just above zero.

(See “The Mixed-Up Math of Negative

Rates—and What It Means for You,” on

page L10.) That means there’s not

much room for return, and there is

greater vulnerability to interest-rate

risk. When rates rise, new bonds are

issued with higher coupons, or interest

payments. That makes existing bonds

less attractive, and prices drop. The

closer a bond is to maturity, the less

interest-rate risk it carries—a measure

known as duration.

To simplify the need for safety, advi-

sors recommend matching bond funds

with time horizons. Money needed to

cover, say, a coming expense or income

needs over the next three years should

be in cash or short-term government

bond funds. Note: Because yields and

returns are low, it’s critical to pay atten-

tion to expense ratios. The $5 billion

Vanguard Short-Term Federal fund

(VSGBX) charges 0.2% and has

returned an average return of 2.8%

over the past 15 years, with little

volatility along the way.

Long-duration government bond

funds tend to be uncorrelated to stocks,

though they aren’t immune to volatility.

The Pimco Extended Duration fund,

for example, lost 21% of its value in

2013, as the Federal Reserve indicated

that it would soon end its quantitative

easing—investors sold long-term bonds

fearing what would happen if the Fed

stopped its bond-buying program. The

very next year, though, the fund re-

turned 45% as rates fell again. (Its ef-

fective duration, by the way, is 26 years,

versus 16 years for the category.)

Because long-term Treasuries can be

so volatile, says Sjoblom, intermediate-

term bond funds tend to be better di-

versifiers for individual investors.

These funds don’t rise as much as long-

term bonds when stocks tank, but they

also don’t swing as wildly. The $6.6

billion Vanguard Intermediate-

Term Treasury fund (VFITX) is a

proven and low-cost option, beating

96% of its peers over 15 years. Miguel Porlan