Our Fund Analyst Picks Do Battle with the Top Bond Index

This article appears in the August issue of Morningstar FundInvestor. Each month we track how our Fund Analyst Picks have done overall and then drill down to examine how one category's picks performed.In addition to an article on the picks, we have a table displaying overall performance and graphs charting the performances of our individual picks in one category.

Intermediate-bond funds are at the heart of the bond world. Most of the bond market's value and many of the best bond funds can be found in the intermediate category. We've identified some attractive funds among that bunch, as our picks' records through June 2007 attest.

The newest entrant is  Fidelity Total Bond (FTBFX), which we picked in May, so it therefore lacks a meaningful record as a pick. Of the seven that have been picks for a while, all have beaten their category average. More impressive is that five of our six actively managed funds have beaten the Lehman Brothers Aggregate during the period from the time they were picked through the end of June 2007.

It's no surprise that  Vanguard Total Bond Market Index (VBMFX) lagged its benchmark--nearly all index funds do after expenses are taken out. Since we picked the fund in 1999 it has beaten the category average but lagged the index. It did have one unwelcome moment of excitement since it was a pick. Back in 2002, the fund's design caused it to lag its benchmark by a remarkable 200 basis points. Vanguard had designed the fund to hold more in corporate bonds than the index and that stung when the market punished even high-quality corporate debt in the wake of Worldcom and Enron. Since then Vanguard tightened up the fund's portfolio so that it tracked the benchmark closely, justifying our faith in the fund.

There haven't been any hiccups for the wonderfully dependable  Dodge & Cox Income (DODIX). A pick since January 2000, the fund attempts to beat the benchmark through issue selection driven by its outstanding analyst staff. Slowly but surely, the fund has done just that. In fact, it has beaten the index by a wider margin (44 basis points) on an annualized basis than any of our other picks. This is as good as it gets for bond funds.

 FPA New Income (FPNIX) is a maverick in every way. Manager Bob Rodriguez goes to great lengths to protect the fund's principal and doesn't care if that means that the fund's performance is wildly different from the index's. The fund is way ahead of the index this year as a spike in interest rates and troubling performance for subprime mortgages have many funds barely in the black this year, but FPA New Income is up 2.9%. On the other hand, it lagged by a wide margin during 2004 and 2005. Since we made it a pick in 2000, the fund is 43 basis points annualized ahead of the category average but 19 basis points annualized behind the index.

 Metropolitan West Total Return (MWTRX) got pummeled in 2002 when its telecommunications debt got hammered, but MetWest has been vindicated for holding on. Since we picked the fund in 2001, it has a 31 basis-point edge on the index and a 76 basis-point edge on its peers.

Bill Gross'  Harbor Bond (HABDX) is slightly ahead of the index and peer group since we made it a pick in 2003. (The nearly identical  Managers Fremont Bond (MBDFX) had been a pick prior to that but we switched to Harbor when Fremont ran into some market-timing issues.) If you look out over a longer time period, Gross' record is awesome. However, he has made some weak calls this year and the fund has given up most of its edge on the index.

 Western Asset Core Bond (WATFX) bears some similarities to PIMCO in that it is a huge institutional manager that makes some bold macro calls but avoids straying too far from its benchmark. It's been pretty smooth sailing since we picked this fund in 2004. It boasts a healthy 44 basis point annualized lead on the index and 84 basis points on its peers. I'm amazed more individual investors haven't found this fund.

 TCW Total Return Bond (TGLMX) has held up awfully well for a pure mortgage-bond fund. Jeffrey Gundlach has been rightfully wary of subprime debt, and the fund is still in good shape. Since we picked it in 2005, it's 37 basis points annualized ahead of the index and 72 ahead of its peers.