Barron\'s - April 6 2020

April 6, 2020 BARRON’S•Funds Quarterly L9

Inflation is another big factor that

moves bond prices—and government

bonds in particular. While interest-rate

risk reflects the fear of missing out (on

better yields elsewhere), inflation risk

reflects the fear of losing purchasing

power. Enter Treasury inflation-

protected securities, or TIPS, which

are indexed to inflation.

Inflation isn’t a risk during this re-

cession, but “once a recovery takes

hold, inflation could surprise on the

upside because the massive policy stim-

ulus introduced in this crisis may be

hard to offset quickly enough in the

next expansion,” says Jim Paulsen,

chief investment strategist of the

Leuthold Group. He notes that the em-

bedded inflation rate for TIPS recently

fell below 1%. Inflation expectations are

going to go back up to some degree, he

says, which would be a reason to con-

sider TIPS.

You Want Safety,

But Need Some Income

Many investors don’t want to draw a

definitive line between safety and in-

come, which is why the staple of many

bond portfolios is the intermediate core

fund. There’s more than $1 trillion in

these funds, making it by far the largest

category of bond funds. They own an

array of bonds, including Treasuries,

mortgage-backed securities, municipal

bonds, and corporate credits. Most

stick close to the benchmark

Bloomberg Barclays US Aggregate

Bond Index, known as the Agg, which

was recently 41% Treasuries and about

27% government-backed mortgage-

backed securities.

The funds held up relatively well as

a group during the initial Covid-19

selloff—and for the year through

March 31 are up 1.5%—but there are

wide variations depending on how

much of their exposure was in govern-

ment bonds versus everything else,

especially corporate bonds.

The $53 billion American Funds

Bond Fund of America (RBFGX), for

instance, recently had a 44% allocation

to government bonds. It’s up 3.9% so

far this year, better than 94% of its

peers. The fund’s focus on capital pres-

ervation makes it a solid choice for

investors who prioritize safety, but still

need some upside. Over the past de-

cade, the fund has returned an average

of about 4% a year.

Still, investors shouldn’t be quick to

judge funds that didn’t hold up as well

during the past several weeks. “Many

active managers have historically out-

performed by taking on credit risk,”

Rosenbluth says. “And those areas have

dragged down performance records.”

But that leaves room for greater re-

turn going forward.

“There’s some serious carnage in the

credit markets now, and that is creating

opportunity for opportunistic inves-

tors, for sure,” says Steve Raneri, chief

investment officer of GM Advisory

Group in New York. “In a situation

where you have a fast-moving market

with a lot of dislocation, there’s going to

be winners and losers. You want some-

body to pick through and separate the

baby from the bath water.”

The recent indiscriminate selling

makes it possible for bond fund man-

agers like Mary Ellen Stanek to put

their credit research teams to work.

“We don’t want to be Pollyanna-ish

about the challenging times in front of

us, but we are nibbling,” says the chief

investment officer at fixed-income spe-

cialist Baird Advisors, which manages

the $24 billion Baird Aggregate Bond

(BAGSX).

The fund has lagged behind others

recently because 38% of its assets were

in corporate bonds, versus 26% for the

category average. But the team has a

record of striking a balance between

risk and reward. Over the past decade,

the fund’s 4.3% average annual return

put it in the top 10% of its peer group,

with a good deal of that outperformance

coming from moments like these.

Total Return Is Your Goal—

Within Reason

The second-largest category of bond

funds is intermediate core-plus. Morn-

ingstar began making the distinction in

2019 to indicate funds that, like core

funds, focus primarily on investment-

grade U.S. bonds, but can also hold up

to 35% of assets in below-investment-

grade bonds across all sectors.

“These are managers that have a lot

more flexibility,” Sjoblom says. “When

high-yield spreads become attractive,

they can move in and take advantage of

that market.”

This ability to stray from the bench-

mark has served investors well—until

recently. Between Feb. 20 and March

20, these funds fell an average of 6.5%,

which is a lot to swallow, even for in-

trepid bond investors. In general, the

higher a fund’s exposure to high-yield

debt, the harder it fell.

“The recent selloff and extreme li-

quidity demands have hit every credit

sector,” says Mike Collins, senior port-

folio manager overseeing the nearly $54

billion PGIM Total Return Bond

fund (PDBAX). Prior to Covid-19 panic-

selling, the fund ranked in the top 10%

of intermediate core-plus funds for

every major trailing time period. It’s

down nearly 3% so far this year, and is

now near the bottom of its peer group.

But, again, this is largely due to its rela-

tively light book of government bonds,

recently just 16% of assets.

When the market stops panic-

selling, many of those holdings

should recover, and in the meantime,

Know What You Own

If investors have learned anything in the past month, it’s that bonds are not homogenous and bond funds can lose a lot of money,

even when stocks are also falling. Choose your funds to meet your needs—and expectations.

Bond YTD YTD 5-Year 10-Year

Bond Fund / Ticker Category Return Rank Return Rank Return Rank

Vanguard Short-Term Federal/ VSGBX Short Government 2.5% 38 2.0% 11 1.8% 23

Vanguard Intermediate-Term Treasury/ VFITX Intermediate Gov’t 6.7 23 3.3 11 3.7 5

American Funds Bond Fund of America/ RBFGX Intermediate Core 3.9 6 3.5 3 4.2 12

Baird Aggregate Bond/ BAGSX Intermediate Core 1.5 57 3.1 26 4.3 10

PGIM Total Return Bond/ PDBAX Intermediate Core-Plus -2.9 78 2.9 33 4.5 15

Western Asset Core Plus Bond/ WAPAX Intermediate Core-Plus -2.3 70 3.4 5 5.0* 5

Pimco Income/ PONAX Mulitsector -7.8 41 3.2 9 6.9 2

Note: Data as of March 31. Five- and 10-year returns are annualized. *Institutional share class Source: Morningstar

FlighttoSafety,FleefromCredit

In the first quarter of the year, all but four of Morningstar’s 19 taxable bond fund categories lost money.

Source: Morningstar Direct

1-Month Return through March 20 YTD return through March 31

Long Government

Intermediate Government

Short Government

Intermediate Core Bond

Inflation-Protected Bond

Long-Term Bond

Intermediate Core-Plus Bond

Ultrashort Bond

World Bond-USD Hedged

Muni National Long

Short-Term Bond

Corp Bond

World Bond

Nontraditional Bond

Multisector Bond

Bank Loan

High Yield Bond

Emerging-Mkts Local-Currency Bond

Emerging Mkts Bond

-20% -15 -10 -5 0 5 10 15 20

Treasury

Yields

Investors have

been fleeing to

the safety of

government

bonds, pushing

yields close to

zero. Are nega-

tive yields next?

0.02%

yield on the

1-month Treasury

0.04%

yield on the

3-month Treasury

0.15%

yield on the

1-year Treasury