Not Ready for High Yield? Try These Topnotch Bond Funds

The high-yield bond market's recent rally has been hard to ignore--the typical fund in this category has returned 19% for the year to date through May 29, 2009. That said, the category as a whole was down 26% in 2008, and technical factors including climbing default rates and potentially lower recovery rates for bankruptcies mean that the likelihood for continued volatility is high, and another high-yield sell-off is entirely possible if we don't see improvements in these areas.

So, investors not ready to add a pure high-yield offering to their portfolios would be better-served by sticking with an intermediate-term or multisector-bond fund. While these funds may offer some exposure to high-yield issues, they also offer more diversification in terms of credit quality. Creating a screen for topnotch funds in these categories is a snap with the Premium Screener. Simply screen for intermediate-term and multisector-bond funds that are open to new investment. We limited the results to funds that ranked in the top third of their categories over the past 10-year period, making sure that the current management teams were responsible for the outperformance. Lastly, we required that the funds have expense ratios that fall below the category average as well as investment minimums of $25,000 or less.

Here are some of the results as of May 29, 2009:

For those willing to dip a toe into high-yield bonds,  T. Rowe Price Spectrum Income (RPSIX) is a great choice. A fund of funds, management invests in as many as nine T. Rowe Price funds to get exposure to all sectors of the bond market. As of September 2008, the fund held a 16% stake in  T. Rowe Price High-Yield (PRHYX). While high yield's struggles in 2008 contributed to the fund's 14.7% loss that year, that exposure has also contributed to the fund's 6.3% return for the year to date ended May 29, 2009. One of our Analyst Picks in the multisector-bond category, we've long been fans of the underlying funds as well as this fund's management team.

As for  Metropolitan West Total Return Bond (MWTRX), Stephen Kane, Laird Landmann, and Tad Rivelle have successfully skippered this intermediate-term bond fund since 1997. During the 2009 Morningstar Investment Conference last month, Rivelle explained that his team has been finding some of the best opportunities among investment-grade corporate bonds and is only selectively hunting among higher-yielding issues including BB and B rated issues, as well as bank loans. A focus on residential and commercial mortgage fare in 2008 highlights the managers' contrarian bent, as these issues have been a drag on performance in the past year. So, patience is required to do well here.

And if the volatility in the high-yield bond market makes you too squeamish,  FPA New Income (FPNIX) won't cause you to lose any sleep. The fund has a stellar long-term record, and manager Bob Rodriguez has maintained a "buyer's strike" against high-yield bonds (as well as long-duration U.S. Treasuries) in recent years as a result of his top-down calls. While Rodriguez is set to take a one-year sabbatical starting January 2010, we take comfort in that he is handing the baton to his experienced comanager, Thomas Atteberry. Plus, Rodriguez is retaining his ownership stake in FPA and intends to return to the fund as assistant manager post-sabbatical.

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