These Fine Bond Funds Fly Under the Radar

During the past 12 months we have seen enormous flows into taxable-bond funds, with nearly $160 billion added to the asset class, while about $136 billion has been pulled out of stock funds as of the end of May. 

For many investors, finding a bond fund means going large. As the popularity of the mammoth  PIMCO Total Return (PTTRX), with its $263 billion asset base, shows, many investors head for familiar names when adding to their bond holdings. And even though there are plenty of quality bond funds offered by PIMCO, Fidelity, Vanguard, and other large fund families, there are also plenty of smaller, lesser-known bond funds with good managers and processes at attractive prices.

With this in mind, we set out to identify highly rated taxable-bond funds that might be of interest to investors willing to look at funds that haven't gotten much fanfare. We turned--where else--to the Morningstar  Premium Fund Screener tool and filtered on taxable-bond funds with $5 billion or less in assets and Morningstar Analyst Ratings of Bronze or better. We excluded load and institutional funds as well as those that are closed to new investors. Premium members can see the full screen  here. Below we've provided a sampling of those on the list. 

 Osterweis Strategic Income (OSTIX) (
)Assets: $2.4 billion
Though technically a go-anywhere fund, Osterweis Strategic Income currently invests solely in corporate bonds and convertible securities (76% of assets), with the remainder of assets in cash. The fund favors high-yield, shorter-term issues primarily, with an average credit rating of B and average duration of 2.2 years. The fund's attractive 5.7% yield carries with it the risk that global economic problems, including Europe's sovereign debt crisis, could hurt some of its riskier holdings. The fund is run by a seasoned, disciplined management team and has beaten the Barclay's U.S. Aggregate Bond Index on average by about 3 percentage points annually during the past three years. Expenses, once as high as 1.50%, have fallen to 0.92%, below-average for the multisector-bond category, as assets have grown.

 T. Rowe Price Emerging Markets Bond (PREMX) (
)Assets: $3.4 billion
Emerging markets as a potential destination for fixed-income investors was a hot topic at this year's Morningstar Investment Conference, and this is one of the few funds that Morningstar analysts recommend in the category. The fund, which is among the larger offerings in its category, employs a broadly diversified approach. Its regional and country allocations tend to stay in line with the JPMorgan EMBI Global index, but lead manager Michael Conelius isn't afraid to venture into less commonly traded frontier countries such as Iraq, Serbia, and Vietnam. Nearly half the fund's portfolio is in corporates, about 20% higher than the category average, and the fund also invests in bonds denominated in local currencies. Broad diversification across sectors and across more than 50 countries has helped keep volatility low relative to its peers. The fund has outperformed the emerging-markets bond category in seven out of the past eight years, and its 0.94% expense ratio is low for the group.

 USAA Short-Term Bond (USSBX)
Assets: $2.6 billion
This fund's managers aren't afraid to bet on sectors they feel the market undervalues. For example, even though this is a taxable-bond fund, they added municipal bonds two winters ago even as others fled amid default fears (munis now make up about 7% of the portfolio). And since 2010, they also have increased their stake in midquality corporate bonds, believing them to be cheap compared with higher-rated issues. The fund holds virtually no government debt, which is unusual in a category in which such debt averages 16.4% of portfolios, and it overweights securitized debt, which makes up nearly half of its holdings. Although the fund lost 2.6% in the 2008 market meltdown, it has delivered at or near top-quartile returns every year since then. At 0.62%, expenses are average relative to other no-load short-term bond funds. 

Portfolio data as of March 31 for Osterweis Strategic Income and T. Rowe Price Emerging Markets Bond, as of Jan. 31 for USAA Short-Term Bond.