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Fund Spy

The Decoupling

Core bond funds continue to migrate away from their lodestar.

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Of all the mutual fund categories that have undergone changes since the 2008 financial crisis, few if any can lay claim to the combination endured by the intermediate-term bond category, home to most core offerings in the bond-fund universe. Back then a notable group of funds claiming just under $500 billion in assets, the category has mushroomed as investors have fled equity market volatility, and its size now registers at nearly $930 billion.

The group has done much more than simply grow, however. As we discussed in a piece this past July, fund managers have also meaningfully changed the way that they've been managing core portfolios. Most intermediate-term bond funds use the Barclays Capital U.S. Aggregate Bond Index as their benchmark, and one trend that was especially visible in 2011 was a willingness on the part of managers to run their portfolios with less interest-rate sensitivity than that bogy. Many were worried that, even after a late 2010 spike, Treasury yields were still too low and that a nascent economic recovery would result in a yield spike that would push down the prices of longer-duration portfolios. The economy proved less robust than expected, however. At the same time, fears of contagion from Europe's problems drove down the prices of riskier assets in the late summer, while triggering a massive Treasury bond rally that saw the 10-year note go from 3.65% in February to levels around 2% in August (and ever since). Fewer than 12% of funds in the category managed to match or beat the return of the Barclays Aggregate Index for the year.

Eric Jacobson has a position in the following securities mentioned above: PTTRX. Find out about Morningstar’s editorial policies.