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By Michael Rawson, CFA | 04-11-2014 06:00 AM

'No Income' No Reason to Ditch Core Bonds

As bond-fund returns are expected to stay volatile, high-quality intermediate bonds provide greater portfolio stability than higher-yielding, nontraditional bonds.

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Mike Rawson: After several years of favoring bond funds over stock funds, investors rotated out of bond funds in 2013 as the Federal Reserve started to reduce its asset-purchase programs. Since then, interest rates have risen to about 2.7% and the performance of intermediate-term bond funds has suffered because of that. Last year, the average intermediate-term bond fund was down about 1.5%.

So far in 2014, selling of core bond funds has slowed. In fact, in March, the intermediate-term bond category had its first month of inflows in 11 months. To reduce interest-rate risk, investors have put money into short-term bond funds, but some investors have added money to noncore bond funds, as well. Noncore bond funds may have less exposure to interest-rate risk, but it's also likely that they have exposure to other risk factors such as equity market risk.

With uncertainty over the future course of interest rates, it's likely that bond-fund returns are going to be more volatile in the future. It's important to remember the two reasons why investors hold bonds in their portfolio; one, reason is for income and the other reason is for stability in your portfolio. While investors may not be getting much income out of high-quality bonds,, high-quality bonds are likely to provide greater stability to your portfolio than non-traditional bonds and bond funds. 

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