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By Christine Benz and Eric Jacobson | 01-16-2014 03:00 PM

Top Bond-Fund Picks for Retirees

Morningstar's Eric Jacobson runs the gamut with some of his favorite fixed-income funds, including ideas for core, short-term, multisector, high-yield, and muni exposure.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Although interest-rate worries roiled the bond market in 2013, bonds are still a key component of many retirees' portfolios. Joining me to share some of his top fund picks is Eric Jacobson. He is a senior fund analyst with Morningstar.

Eric, thank you so much for being here.

Eric Jacobson: It's good to see you, Christine. Thank you.

Benz: Eric, we did a similar video like this a couple of years ago. It was very much a favorite of some of our readers and users of Morningstar.com. So I thought we'd cycle back through in light of these headwinds that seem to be facing the fixed-income market right now.

I'd like you to share some of your top ideas for retiree portfolios, and I'd like to start with what you think of as good core anchor funds for retirees. And maybe we'd want to think about funds where people have, say, a five-year time horizon or thereabouts. What types of fund should they be looking at if that is their time horizon?

Jacobson: Let me talk a little bit in terms that are a little more common among institutions; pretty simple though. Generally, we talk about them in terms of being either core or core-plus.

Core is funds that attract the Barclays Aggregate Bond Index, which is sort of, as you know, the S&P 500 of the bond market. It's very high quality; it's focused a lot on government bonds, mortgages, and high-quality corporates.

Core funds pretty much tend to stick almost exclusively with those sectors. They usually have a duration-management policy that keeps their interest-rate sensitivity kind of close to the core. And even if they might branch out a tiny bit, they very rarely take on much extra risk outside of the index.

The core-plus-type funds often have the ability to have maybe 10% or 15% in high yield, maybe some emerging markets, a little bit more non-U.S.-dollar underlying bonds, and then things like non-agency mortgages, asset-backeds, and commercial mortgage-backeds. Some of those are higher-quality things but not well represented in the index.

I differentiate between the two in terms of portfolio construction by thinking, if I really want to do some of my own work selecting funds in general, maybe then you want to start with the real core fund that doesn't branch out that much, use that as your anchor, and then build other funds around it, whether they'd be high-yield, emerging markets, et cetera. That way you not only do get to choose the sectors and the exposures but you get to pick managers that you like, rather than relying on your core manager to pick from all those sectors.

On the other hand, if you want to maybe have a little bit more inclusive fund and want to give a manager the ability to branch out a little more, especially, if he or she thinks that there's some value to be had in some of those areas, then you want to maybe look at a core-plus fund.

The biggest, baddest one that everybody knows about is PIMCO Total Return. Manager Bill Gross does that kind of thing in that fund. He also manages, as you know, Harbor Bond and Managers PIMCO Bond, both of which pursue almost exactly the same strategy. The portfolios aren't always identical, but pretty much have the same strategy. Those two funds are no-load and cheaper, as you know.

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