3 Bond Funds for a Rising Interest-Rate Environment

Russ Kinnel: Hi. I'm Russ Kinnel, director of manager research at Morningstar. The Federal Reserve raised interest rates a quarter point in March, and it signaled there will be more interest-rate hikes to follow. A fast-growing economy paired with surging inflation have spurred the Fed into action.

Rising interest rates are a bad thing in the short run for most bond funds, so you might want to think about how to play some defense if you have a bond-heavy portfolio. The obvious choice is bank-loan funds. Bank loans adjust their yields with interest rates so that rising interest rates don't hurt their value the way you see with regular bonds that pay a fixed yield.

When you pick a bank-loan fund, be sure to pick a seasoned manager backed by a strong team because running a bank-loan fund is challenging. Bank loans are less liquid than most securities found in a mutual fund, so the manager has to maintain a sleeve of more liquid holdings such as cash and higher-quality bank loans. In addition, bank loans come with a fair amount of credit risk, so you need a deep research team to avoid dicier loans that might blow up on the fund.

We rate T. Rowe Price Floating Rate Gold because Paul Massaro and team have produced strong returns with moderate risk.

Another favorite is Silver-rated Fidelity Floating Rate High Income. Eric Mollenhauer has proved an adept investor who has led the fund to consistent outperformance.

My final pick is an inflation-protected fund rather than a bank-loan fund. Inflation generally moves in the same direction as interest rates, though there are times when they are not quite in sync. Thus, these funds can be another tool for protecting your portfolio. Vanguard Short-Term Inflation Protected Securities Index provides inflation protection without much interest-rate risk. And, of course, costs are super low at just 6 basis points here. We rate that fund Gold.

Thanks for watching. I'm Russ Kinnel