Don't Overlook These Solid Core Bond Options
A handful of funds have gotten all the love in the wake of Bill Gross' departure from PIMCO, but investors can widen their scope.
Note: An earlier version of this article named AMG Managers Bond (MGFIX) as a near-clone of PIMCO Total Return (PTTRX), which it is not.
Bill Gross' departure from PIMCO and the firm's flagship fund, PIMCO Total Return (PTTRX), set off a chain reaction among bond investors.
Some investors pulled their assets immediately, concerned that an avalanche of outflows could cause a run on the fund that would force management to accept fire-sale prices for its holdings. Alas, that didn't happen; a healthy slug of PIMCO Total Return was parked in highly liquid Treasury bonds.
Other investors were more deliberate, selling a month or more after Gross' departure. In all, more than $100 billion left PIMCO Total Return during the seven-month period through March 2015. For its part, Morningstar continues to recommend the fund, but downgraded it from a former Gold rating to Bronze, owing to concerns about the upheaval at the firm in the wake of Gross' departure.
Most of the dollars leaving PIMCO Total Return did not follow Gross to his new charge, Janus Global Unconstrained Bond (JUCAX), which lands in Morningstar's unconstrained-bond category. That fund recently had just $1.5 billion in assets, a healthy share of which was Gross' own cash. Instead, former PIMCO Total Return investors swapped into other similarly flexible, core-type intermediate-term bond funds: Metropolitan West Total Return (MWTRX), Dodge & Cox Income (DODIX), and DoubleLine Total Return (DBLTX) have each seen substantial new inflows in the wake of the changeover at PIMCO. Vanguard Total Bond Market (VBMFX) has also been a beneficiary. While it's less flexible than the actively managed funds--as a Barclays U.S. Aggregate Bond Index tracker, it's heavy on government-issued and -related bonds--investors have no doubt been attracted to its low costs and ability to diversify an equity portfolio.
With the exception of DoubleLine, all of those funds currently earn Morningstar Analyst Ratings of either Silver or Gold, so investors are making sensible choices. That said, investors in search of a worthwhile core bond fund might also reasonably look beyond the usual suspects to funds that haven't yet gotten extremely large.
True, the jury is out on how big of a deal "asset bloat" is for bond funds. In this video, senior analyst Eric Jacobson notes that bond funds that buy highly liquid government and mortgage-backed bonds--including many in the intermediate-government and intermediate-term bond categories--will tend not to be bothered by asset size.
But growth may have implications for the way a more "vanilla" bond portfolio is managed. Bond managers who use derivatives to express their market outlooks may be able to successfully manage more girth than managers who focus more on bond-picking to make a difference. PIMCO Total Return and its various clones, for example, were able to deliver peer-beating returns for many years even though the fund grew too large for bond-picking to make a significant difference in its returns. At its peak, PIMCO Total Return had nearly $300 billion in assets, and Gross managed various pools of money in that same style for other entities, too.
On the flip side, funds that aim to differentiate their returns with bond-picking--versus sector maneuvers and yield-curve plays, for example--will tend to benefit from being nimble. To help unearth worthwhile core bond funds that aren't yet swinging around enormous asset bases--and, therefore, might be a bit more agile than the big (and growing) PIMCO Total Return beneficiaries--we used our Premium Fund Screener. We homed in on medalist intermediate-term bond funds with asset bases of $10 billion or less that are still accepting new investor dollars.
Of course, $10 billion is not a small number, so this cutoff doesn't guarantee the funds that make the cut are necessarily fleet of foot; nor is there any guarantee that these funds employ strategies where being small would even be an advantage. Moreover, looking at assets on a fund-by-fund basis can paint a misleading picture, in that funds that appear small on a standalone basis may be part of a much larger pool. Harbor Bond (HABDX) made the cut in our screen, for example, even though it's a near-clone of the still-giant PIMCO Total Return.
Premium Members can click here to view the screen's complete output; below are descriptions of a few of the funds that made the cut.
American Century Diversified Bond (ACBPX)
Analyst Rating: Bronze | Asset Size/All Share Classes: $5.4 billion
In contrast with some of its very large peers, security selection has helped differentiate this fund's returns; it stands to reason that not being enormous would help management preserve its ability to add value through bond-picking. Analyst Gretchen Rupp notes that in 2014, for example, management focused on low-loan-level mortgage-backed securities that outperformed; those positions helped offset the fact that management was leaning the wrong way with the portfolio's duration and yield-curve positioning. The fund has historically maintained a higher-quality portfolio than many of its peers; Rupp points out that that positioning has held its results back in credit-friendly markets such as 2009, but it has helped the fund hold up much better than rivals in credit sell-offs like 2008. While it's bound to be sensitive to interest-rate changes, the fund provides the sort of "insurance protection" I discussed in this article. The Institutional share class, which is the largest, made it through our screen, but smaller no-load investors can buy into the Investor share class with a $2,500 minimum initial investment.
Fidelity Intermediate Bond (FTHRX)
Analyst Rating: Silver | Asset Size/All Share Classes: $3.3 billion
For investors seeking a core intermediate fund that shies away from interest-rate risk, this offering fits the bill nicely. Unlike many of its peers, which benchmark their durations to the Barclays U.S. Aggregate Bond Index, this offering keeps its duration in line with the Barclays Intermediate/Government Credit Index, which is substantially shorter. That shorter stance has held it back as yields have declined--and stayed low--for the past several years, but could prove beneficial in a rising-rate environment. In 2013's "taper tantrum"-induced rate shock, for example, the fund held up better than most intermediate-term bond funds. Analyst Vishal Mansukhani notes that management aims to add value through yield-curve and sector positioning, as well as security selection, and draws upon the firm's large team of researchers to help it get those calls correct.
Loomis Sayles Core Plus Bond (NEFRX)
Analyst Rating: Gold | Asset Size/All Share Classes: $7.2 billion
Whereas the American Century and Fidelity offerings employ restrained strategies relative to their peers, this fund runs to the riskier side of the intermediate-term bond group. Senior analyst Sarah Bush notes that the fund has more latitude to invest in junk bonds than does its typical peer, and it also ventures overseas; a recent portfolio featured more than 20% in emerging-markets names, including some non-dollar-denominated bonds. Those emphases have contributed to a few stumbles in recent years; Bush notes that its results during the "taper tantrum" were among the worst in the intermediate-term bond group. Of course, the market has generally rewarded risk-taking during the past six years, so its trailing returns and rankings look stellar. Moreover, the fund draws upon Loomis' formidable team of 40-plus credit researchers. Investors may pay a sales charge if working with a commission-based advisor.
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Christine Benz does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.