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By Christine Benz and Eric Jacobson | 08-22-2013 03:15 PM

Bond Funds Undergo a Stress Test

Senior fund analyst Eric Jacobson walks us through how some of Morningstar's top-rated intermediate-term bond funds fared during the early summer sell-off.

Christine Benz: Hi. I'm Christine Benz for The recent interest-rate shudder provided a good stress test for bond funds. Joining me to provide a look at how Morningstar's top-rated intermediate-term bond funds did during the early summer period is Eric Jacobson. He is a senior fund analyst with Morningstar.

Eric, thank you so much for being here.

Eric Jacobson: Good to be here, Christine. Thanks.

Benz: Eric, let's do a little stage setting. The bond market sold off in May and June, and that was only because Ben Bernanke indicated that the Fed may start tapering this bond-buying program that it's been on, but the Fed didn't actually take action. So why do bond prices react even when the Fed hasn't actually taken action yet?

Jacobson: Well, it's just like you've seen sometimes in the equity markets, as they say, things get priced in early sometimes. So in this case, it's all about fear. Everybody is worried that the biggest buyer in the bond market is going to pull back and not be there, and that just sent shock waves through the marketplace and triggered all that worry in a sell-off and brought yields up to a place where they hadn't been for quite a while.

Benz: Right, for couple of years even. You looked at our top-rated, our Gold- and Silver-rated intermediate-term bond funds, at how they performed during this period, and you really found quite a cross-section of different results. What was the general range when you looked at results for our highest-conviction funds during this particular period?

Jacobson: Right, and again, it's important to mention these are the highest-rated funds in the intermediate-bond categories, it's not the category itself. But one of the best performers was  Dodge & Cox Income DODIX, and it only lost about 2% during the two-month period, and one of the worst was  PIMCO Investment Grade Corporate PIGIX, which lost more than 6% during those two months.

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