Nominees for Morningstar Bond Manager of the Year

Bonds are back. For the second straight year they've beaten stocks. Their 6% returns look pretty good compared with the 10% or 15% losses many stock funds have posted. Falling rates gave bond funds a nifty tailwind and about the only danger spot was high yield. Telecommunications companies have been huge issuers of junk bonds and many of those bonds are now worth pennies to the dollar because a glut in fiber-optic lines has led banks and Wall Street to shut off the spigot to telecom companies.

Our nominees posted outstanding results, but they bring some very different approaches to their work. On one side are two bold mavericks: Margie Patel and Bob Rodriguez are not index huggers. They make bold bets and are skilled enough to make them pay off. On the other side are three big teams of managers making scores of modest bets that have worked out well.

American Funds' Muni Team--American Funds Tax-Exempt Bond Fund (AFTEX)
This fund's 5.3% return might not sound like a lot, but it's actually quite good. In recent years, municipal-bond yields have been coming down significantly, so it's not easy to post a return north of 5%. The fund has earned top-decile returns for this year and the trailing five- and 10-year periods as well, thanks to three things: Mixing in lower-quality bonds, strong research, and low expenses. You're generally better off with a muni fund that invests in high-quality debt, but some have the skill to make it pay off. This is one of those funds. Most of the assets are in high-quality bonds but a slug are high-yield (i.e., low quality) bonds. American makes that work by diversifying into a lot of bonds and by doing the research to avoid Heartland-like disasters.

Dodge & Cox's Fixed Income Team--Dodge & Cox Income (DODIX)
If you like consistency, you gotta love Dodge & Cox Income. The fund has beaten the average intermediate-bond category for nine straight years. They focus on security selection rather than macro bets. Thus, whether interest rates are rising or falling, this fund can still outgun its peer group if management picks the right bonds. In order to get the most out of their research, management generally buys bonds with call protection so that the value of their research can't be quickly wiped out when a bond is called. At the risk of sounding like a broken record, this fund's trailing returns all land in the top decile of the intermediate-bond category.

Fidelity's Muni Team--Fidelity Spartan Intermediate Muni Income (FLTMX)
Fidelity's approach isn't too different from that of American or Dodge & Cox. They tightly stake duration and credit quality to their benchmark so there won't be any nasty surprises for shareholders. Fidelity then attempts to beat its bogies through issue selection. This process won't make shareholders rich quick. In a great year like this one they beat their category average by 100 basis points or so and in a bad one they beat the average by 20 basis points. Needless to say, they're whipping their peers. This year, this fund's 5.42% returns land in the top 5% of its category while other Fidelity muni funds are also top 10%.

Margie Patel--Pioneer High Yield (TAHYX)
If there were a slaughter rule in investing, the game between Patel and the high yield category would be called off. Patel is up 15.75% this year while the average high-yield fund is up 1.75%. Furthermore, for some high-yield funds the picture is much worse. Some prominent funds like Invesco High-Yield  have double-digit losses due to telecom companies going bust or being on the brink. Patel mixes in convertible bonds where the equity option is of little value along with more traditional high-yield fare. In three years at the fund, she has taken the fund to the top 2% of her category in each calendar year. Patel boldly runs her fund in much the same way a focused stock-fund manager would. She invests a good chunk of assets in her top picks and spends most of her time examining balance sheets. Though she has only three years of experience at this fund, she's been managing bond portfolios for 20 years.

Bob Rodriguez--FPA New Income (FPNIX)
Bob Rodriguez hates to lose money. In his 17 years at the helm, he hasn't had a single year in the red. In 1994 when bonds got crushed, he still came through with a 1.4% gain. He guards against every risk with a passion. To guard against inflation, he buys inflation-protected bonds and maintains a moderate duration. To guard against defaults, he sticks with high-quality debt and he's picky about what he buys. Despite that, Rodriguez has still put up big returns in rallies. The fund's up nearly 12% this year while the average intermediate-bond fund is up just under 7%. If you look out over the trailing one- to 10-year period, the fund's returns rank in the top decile of the intermediate-bond category. Rodriguez won Manager of the Year back in 1994 and he's got a shot to repeat.

Poll Results
Last week, I asked which manager would be most likely to steer clear of the next Enron . About 54% of you picked Bill Nygren who manages Oakmark (OAKMX) and Oakmark Select (OAKLX).