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Bond Fund Picks to Keep It Simple

Jason Stipp

Jason Stipp: If you've been on recently, you've probably read a little bit about the difficult or cloudy environment that might be facing bond investors. Morningstar's Christine Benz, director of personal finance, says there is a way that you can account for some of these things and keep it simple with your bond portfolio. She's here to tell us how. Thanks for joining me, Christine.

Christine Benz: Jason, great to be here.

Stipp: So the first question for you. It seems like there are a lot of concerns out there about the bond environment. Can you highlight a few of those and why people are worried about their bond investments?

Benz: Well, the big one is that there's concern that future interest rates really have only one direction to go, and that's up. So, while there's some difference of opinion on that subject, some people actually think that rates will hold steady or maybe even go down, generally, the consensus is that rates will go up, and that will hurt bond prices.

So that's the big concern. Particularly when you've seen the kind of stampede that we have into bond investing, you have to wonder whether there aren't some areas of the bond market that are overheated right now.

And then there's also the headwind of inflation. So, when you're earning a fixed rate on your investment, any sort of inflation is going to cut into your take-home return, so that's another concern there, too.

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Stipp: So, certainly, definitely all very relevant reasons and things that bond investors should have on their radar. Given that, is it good news or bad news that there are so many options these days for bond investors and so many different types of bonds that they can target and invest with specific kinds of funds? How should I think about all of those?

Benz: It's good and bad news, I guess, Jason. And with the proliferation of ETFs slicing and dicing the fixed-income universe, really, the whole market universe, into ever-finer segments, I think it's easy to get confused.

And that's something that I see investors run into. They are trying to decide, "Do I need a dedicated, say, Ginnie Mae Fund? Do I need an intermediate corporate fund? Should I be in munis?" et cetera. So investors really wrestle with those decisions and how to assemble a sensible fixed-income portfolio.

Stipp: Or they may read about trouble in one area and wonder if they should get out of that, and then they may read about some opportunity somewhere else and want to get into that.

So, given that there's all these different ideas out there, there's all these different concerns, I think you're always a proponent of keeping it simple, is there a way to keep it simple here and keep these concerns at top-of-mind?

Benz: Well, one easy strategy, and one that I would recommend long term, would be indexing. But a big drawback to indexing right now is that most of the broad bond market indexes skew heavily toward government-issued debt. And there are a lot of concerns about all the issuance that the government has done and whether that could be a headwind, long term, for government bonds.

So, I know our fixed-income fund analysts at Morningstar have generally been a little bit lukewarm on buying some of the total bond-market indexes right now and would, in fact, favor a more actively managed fund that can jockey among different market segments, and most of them would be tending to downplay government bonds at this time.

Stipp: So, basically, when you think about active management, you're basically paying a manager to make some of these decisions for you instead of just following an index. So, if we do want to outsource that, and we think that a manager can add value that way, where should we start? What are some good managers to take a look at?

Benz: Well, I would start with the intermediate-term bond fund category for a view of funds that have kind of wide open tool kits. Some of these funds can invest internationally as well as domestically. They can move among different maturities.

So a few that come to mind would be PIMCO Total Return, the juggernaut there; Harbor Bond, which is a no load clone of PIMCO Total Return. Metropolitan West Total Return Bond is another idea, also a very opportunistic fund, one that has probably done a little less in international than has the PIMCO and Harbor bonds. And then, also, Dodge & Cox Income is another very low-cost, very opportunistic, value-oriented, fixed income fund. I have a high level of confidence in all of those funds.

At the short-term end of the spectrum, I would look to T. Rowe Price Short Term Bond, one of our fund analysts' favorites. There's a fund that has not been too heavy on the government bonds. It has historically skewed toward corporates but has done a good job of being opportunistic, being flexible.

Stipp: Look at some good managers that have the flexibility to go where they're seeing the opportunities.

Benz: Right. I would also do the same if you're someone in a higher tax bracket. Take a look at any of the Fidelity muni funds, which, too, have been sort of opportunistic funds that have done very well historically and have nice, low costs.

Stipp: Christine, thanks so much for your insights and the ideas for keeping it simple in this very tense space right now.

Benz: Thanks, Jason. Nice to be here.

Stipp: For Morningstar, I'm Jason Stipp.