These intermediate-term taxable-bond funds earn Morningstar Analyst Ratings of Gold.
Last week, we published a checklist for taxable-bond-fund investors. In it, we suggested that investors select intermediate-term bond funds for the core of their fixed-income allocations. By dedicating a sizable chunk of your fixed-income allocation in such funds, your portfolio will be better positioned to withstand bond-market shocks from interest-rate increases or credit-quality scares. Plus, you'll get the diversification benefits that bonds can offer an equity-heavy portfolio.
Investors who want funds that own only the highest-quality intermediate-term credits can focus their efforts on funds in the intermediate-government Morningstar Category. Those willing to include corporate bonds and other fare in addition to governments can survey the intermediate-term bond category. "I personally prefer the latitude you see in the intermediate-term bond category, because it offers more diversification," says Morningstar director of personal finance Christine Benz.
Investors seeking core bond funds for their portfolios can begin their search with this shortlist of the best funds in the two intermediate-term taxable-bond categories. Each fund listed here earns a Morningstar Analyst Rating of Gold. Funds that earn Gold ratings are expected to outperform during a full market cycle.
Finding the Best Fit
The most dominant name on the list is Fidelity. "The dependable fixed-income division remains a crown jewel, though it's often overshadowed by the larger equity division," notes analyst Sarah Bush. The two intermediate-government funds, Fidelity Government Income FGOVX and Fidelity GNMA FGMNX, share the same management team of Bill Irving and Franco Castagliuolo. The team avoids duration bets and instead looks for pockets of value within the funds' respective universes. Meanwhile, Fidelity Total Bond FTBFX manager Ford O'Neil also maintains a benchmark-neutral duration, but pursues opportunities across high-quality bond sectors, and even delves into high-yield and emerging-markets debt. All three funds benefit from Fidelity's rich fixed-income resources. "Fidelity has invested heavily in its fixed-income operations," notes Bush. "O'Neil and his colleagues have access to a variety of tools to slice and dice the broad portfolio's risks and identify opportunities in individual credits and mortgage pools." Low expenses add to the appeal.
Loomis Sayles claims two spots on the list with Loomis Sayles Core Bond Plus NERYX and Loomis Sayles Investment Grade Bond LSIIX. "[Loomis Sayles] employs a value-driven, credit-intensive approach and is always on the lookout for securities and currencies it believes are undervalued," notes Bush. Although the Loomis Sayles funds vary slightly in their mandates, "a number of themes run across this team's portfolios, including an emphasis on midquality corporates and nondollar bonds," adds Bush. As a result, these funds are more tightly correlated with the S&P 500 than many other intermediate-bond funds, and they can struggle during flight-to-quality periods, such as the one we experienced in 2008. They also offer less diversification to an equity-heavy portfolio. Nevertheless, these funds have delivered some of the best returns in the intermediate-bond category during the trailing five-, 10- and 15-year periods.
"A veteran and well-resourced team, time-tested process, low expenses, and an impressive long-term track record earn Dodge & Cox Income DODIX a Morningstar Analyst Rating of Gold," notes analyst Cara Esser. The fund's management team seeks to outperform the Barclays U.S. Aggregate Bond Index while minimizing the risk of loss; the fund also emphasizes income and, therefore, tends to yield more than its index and peers. The fund's duration is usually shorter than that of its index, which helps dampen interest-rate risk. Because of its emphasis on income as a driver of total return, the fund overweights agency mortgages and corporate bonds for their incremental yield advantages over straight Treasuries. Esser notes that the fund's emphasis on corporate bonds, in particular, can lead to underperformance in years such as 2011, "when negative macroeconomic trends make headlines."
Unlike some other managers mentioned here, the team at Metropolitan West Total Return Bond MWTIX actively manages the portfolio's duration. It's also able and willing to invest outside of the index, adding high-yield corporates and nonresidential agency mortgages to the mix. As such, the fund carries a more aggressive credit profile than some other funds in the intermediate-bond category. "This fund is run by value investors looking to buy bonds when they're fundamentally cheap and sell them when they get expensive," sums up analyst Karin Anderson. As of this writing, that value-driven approach has led to top-decile returns for the trailing 10-year period.
The final fund on the list, Vanguard GNMA VFIJX, is subadvised by Wellington Management. Manager Michael Garrett sticks largely with Ginnie Mae pass-throughs, and avoids esoteric mortgage-backed securities. The fund is, therefore, a good choice for investors seeking pure, high-quality bond exposure. It's one of the lowest-cost actively managed intermediate-term bond funds around: The Admiral shares require a $50,000 minimum and carry an expense ratio of just 0.11%; the Investor shares require a $3,000 minimum and levy a still-modest 0.21% expense ratio.
Of note, not a single index fund in either of the intermediate-term categories earns a Gold rating. Why not? "Many of the large firms that we cover in that space track the Barclays U.S. Aggregate Bond Index," explains analyst Tom Boccellari. "While funds such as Vanguard Total Bond Market Index VBTLX do a great job tracking that index at a low cost, the index may not be the best way to get long-term performance in those particular categories." Because the Barclays U.S. Aggregate Bond Index focuses largely on Treasuries and longer-duration securities, it carries significant interest-rate risk, which will be a disadvantage if interest rates rise. As a result, "We feel that, in the long run, the Barclays Aggregate Index funds will underperform Gold-rated active funds because of the limitations of the bond index," says Boccellari.
Premium Members can access a complete list of Morningstar Medalist taxable-bond funds (both core and noncore) below: