Bond Funds That Have Taken the Market's Ups and Downs in Stride

In last week's Five-Star Investor article, we discussed upside and downside capture ratio and how this useful statistic can help investors determine how a fund has behaved relative to a benchmark in both rising and falling markets. You'll recall that an upside capture ratio above 100 means that a fund outperformed its benchmark in months when the benchmark went up while a downside capture below 100 means the fund outperformed--or lost less--than its benchmark in months when the benchmark went down.

We started by looking at large-cap stock funds and how they've performed relative to the S&P 500 during the past decade, focusing on those rare funds that have outperformed the index both to the upside and to the downside. This week we turn our sights to the fixed-income side and intermediate-term bond funds in particular.

As many income-oriented investors are aware, the past decade has generally been a pretty good time to own fixed-income vehicles. Declining interest rates that drove bond prices higher, along with a flight to safety following 2008's stock market dive, sent hundreds of billions of investor dollars flowing into bonds and bond funds during that time. But these days, with the Fed hinting that it may begin raising rates next year, many investors are thinking twice about whether owning bonds is a good idea. After all, rising rates reduce the value of existing bonds with lower yields. Yet some investors--including many retirees--desire the lower volatility that bonds can provide relative to stocks along with the higher yields they provide relative to cash.

Whether you are worried about a possible bear market in bonds or think that fears of rising rates are overblown, the upside and downside capture ratios for bond funds, found under the Ratings & Risk tab on Morningstar.com fund pages, can be of use. As with total-return numbers, past performance is no guarantee of future results when it comes to upside and downside capture. But the ratios do provide some guidance as to how a fund might perform during future market ups and downs.

For this week's exercise we started by identifying intermediate-term bond funds that have outperformed the benchmark on both the upside and downside during the past 10 years. (To conduct our research, we used Morningstar's Direct platform for institutional investors.) We then narrowed down this group to the funds that have the widest discrepancies between their upside and downside capture ratios--in other words, those whose performance is particularly noteworthy to the upside, to the downside, or both. We screened out institutional funds, and when multiple share classes of a fund were available, we stuck with no-load and A class shares wherever possible. (In the notable case of  PIMCO Total Return (PTTAX) the A shares did not make it onto our screen because of a downside capture ratio that exceeded 100; however the fund's D shares, which are available through some financial advisors and brokers, did narrowly sneak in thanks to a downside capture that is a hair below our breakpoint at 99.96. Note that different share classes of a fund often have different expense ratios, which can affect overall performance.)

Morningstar uses the Barclays Aggregate Bond Index, which tracks the investment-grade U.S. bond market, as its benchmark for the intermediate-bond category. But the composition of the index can pose a problem when using it to compare the performances of some funds in the category. The benchmark is broadly diversified among different types of bonds, including U.S. Treasuries, corporate bonds, and mortgage-backed securities. But while some bond funds hold ample amounts of all three of these types of securities, others do not. We'll see why this matters in a moment, but for now, let's look at our table. 

Intermediate-Bond Funds With Biggest 10-Year Upside/Downside Capture Ratio Gap
Fund	Upside Capture Ratio	Downside Capture Ratio	Difference	Star Rating	Analyst Rating
TCW Total Return (TGMNX)	106.26	41.95	64.30		Bronze
MetWest Total Return (MWTRX)	113.47	71.46	42.01		Gold
Delaware Diversified Inc (DPDFX)	119.75	89.73	30.02		N/A
Commerce Bond (CFBNX)	104.85	80.50	24.36		N/A
Putnam Income (PINCX)	111.37	87.71	23.65		N/A
TCW Core Fixed Income (TGFNX)	107.62	84.31	23.31		N/A
USAA Interm-Term Bond (USIBX)	113.56	92.49	21.07		N/A
Pioneer Bond (PIOBX)	104.56	83.54	21.02		N/A
JHancock Bond (JHNBX)	116.43	96.77	19.67		N/A
Janus Flexible Bond (JDFAX)	107.14	87.80	19.35		Silver
Wells Fargo Adv Inc Plus	105.80	87.22	18.58		N/A
JPMorgan Core Plus Bond (ONIAX)	102.84	86.70	16.14		N/A
Baird Core Plus Bond (BCOSX)	111.07	95.14	15.93		N/A
PIMCO Total Return	115.47	99.96	15.51		Gold
Touchstone Total Return (TCPYX)	101.27	87.86	13.40		N/A
ASTON/TCH Fixed Income	112.09	99.57	12.52		N/A
Lord Abbett Total Return (LTRFX)	109.29	96.82	12.47		Bronze
Fidelity Total Bond (FTBFX)	106.40	95.10	11.30		Gold
Consulting Grp Core Fxd-Inc (TIIUX)	108.91	99.40	9.51		N/A
USAA Income (USAIX)	108.08	98.63	9.45		Bronze
Data as of Feb. 28

At the top of our list, the 64.3-point difference in  TCW Total Return Bond's (TGMNX) upside and downside capture ratios is rather startling on its face but is partly attributable to the fund's unique focus on mortgage bonds. Looking markedly different from its benchmark and many of its competitors in the intermediate-bond category has been a help, as illustrated by the fund's 41.95 downside capture during the past decade. For example, last year, as Treasuries swooned amid rising interest-rate fears, the index lost about 2%, but TCW Total Return Bond eked out a 1.4% return. In a nutshell, the fund simply doesn't look much like the benchmark, so it's no great surprise that it has behaved differently.

It should also be noted that a good chunk of the fund's performance during the past decade happened under former manager Jeffrey Gundlach, who left TCW in 2009 to start the DoubleLine fund family. Management of the fund was then turned over to a team from MetWest, which also operates the number-two fund on our list.  Metropolitan West Total Return Bond (MWTRX) lacks the strict sector focus of TCW Total Return Bond but also has emphasized mortgage bonds and downplayed Treasuries since the financial crisis, helping it blunt the impact of some of the index's downward movements.

Although the list above features some fine funds, several of which carry Morningstar Analyst Ratings for Funds of Bronze or higher, one of the points made in last week's article bears repeating: Even funds with good long-term records of outperformance can experience rough patches. It's always wise to look at the fund's near-term upside and downside capture statistics to see how it has performed lately as well as what its long-term record has been. In fact, with so much uncertainty in the bond market these days, it's imperative to do so.