Quality Bond Funds That Lagged This Year

Last week we looked at stock funds with good long-term records but that have underperformed in 2012 relative to their peers. The lesson was that a year of below-average performance doesn't necessarily mean you should say goodbye to a good fund--particularly in an up market, when below-average can still mean a healthy return--and that it's best to take a long view in determining whether a fund still meets your needs. This week we turn to bond funds with similar profiles.

This is a precarious time for bond-fund managers, many of whom have seen epic inflows of assets into their funds. Taxable-bond funds added nearly a quarter of a trillion dollars--yes, trillion with a "tr"--in 2012 through November, while municipal funds tacked on an additional $53 billion. At the same time, anticipation that today's historically low interest rates must rise sooner or later has many investors leery of bonds with long durations (measures of interest-rate sensitivity), which are likely to be hit harder than those with short durations, should rates rise. For those who favor active management, this uncertainty underscores the importance of investing with good bond-fund managers with strong track records and good risk controls.

To identify managers such as these, who some investors may have soured on because short-term underperformance but whose good long-term records merit careful consideration, we turned to Morningstar's  Premium Fund Screener. We searched for bond funds with long-term performance records that have earned them Morningstar Ratings for funds of at least 4 stars but that trailed their category averages this year. We also factored in funds with Morningstar Analyst Ratings of Gold or Silver and stuck with bond funds that are suitable as core holdings. Additionally, we screened out institutional funds, those closed to new investors, and those with minimum initial investments of more than $10,000. Premium Members can see the full list  here. Below is a sampling.

 Fidelity Total Bond (FTBFX)    
10-Year Annualized Return: 5.9% | Percentile Rank in Category: 23 | 2012 Return: 6.3% | Percentile Rank in Category: 52    
Lightening up on corporate bonds has caused this wide-ranging fund to fall to the middle of the intermediate-term bond-fund pack this year, atypical for a fund that has delivered annual returns in the top one third of the category all but two years since its 2002 inception. The fund's portfolio is primarily made up of investment-grade fare such as corporate bonds, agency mortgages, and Treasuries. The fund also may hold up to 20% of its portfolio in a mix of high-yield and emerging-markets bonds, which can cause it to lag in rocky credit markets. The fund's deep and experienced management team looks for underpriced market and yield-curve sectors and emphasizes individual security selection. Fees are low at 0.45%.

 T. Rowe Price Tax-Free Income (PRTAX)    
10-Year Annualized Return: 5.1% | Percentile Rank in Category: 24 | 2012 Return: 8.3% | Percentile Rank in Category: 62   
This national municipal-bond fund avoids interest-rate bets but, as a long-term fund, is apt to be more sensitive to rate changes than muni offerings in the mid- and short-term groups. Its managers also have historically made room for more lower-quality credits than its peers. At the same time, its experienced management team helps ensure careful credit research into the lower-quality bonds in the portfolio, with an eye toward unearthing bonds that are of higher quality than their official credit ratings would suggest. In recent years, fund manager Dino Mallas has shied away from state and local general-obligation bonds in favor of those from revenue sectors such as hospitals, airports, and electric utilities. The fund has been a steady performer, landing in the top one third of the muni-national long category for the trailing five-, 10-, and 15-year periods.

Performance statistics through Dec. 20.