18 Standout Bond Funds

Note: This article is part of Morningstar's November 2015 Income Investing Week special report.

Knowing you need bond funds in your income arsenal is one thing; knowing what kind of bond funds you need is another.

The "right" type of bond fund or funds for you comes down to personal preferences. Do you want to stick with the highest-quality bonds you can find, or are you willing to delve into lower-quality bonds in exchange for higher yield? Will you forgo the incremental yield and diversification benefits that high-quality long-term bond funds offer for some protection against rising interest rates? Will you dabble in world bonds for yield pickup--and if yes, do you want currencies in the mix? And does your tax situation make municipal-bond funds attractive?

Two articles can help you figure out what trade-offs you're willing to make in your search for income: "A Checklist for Taxable-Bond-Fund Investors" and "A Checklist for Muni Bond Investors."

Once you have a sense of what you're looking for--and if you already have a bond portfolio, what you may be missing--limit your fund search to the groups that meet your criteria. Morningstar has sliced and diced the bond-fund landscape into a handful of manageable asset classes, listed below. Within each, we list some of Morningstar's favorite funds to get you started.

Domestic Taxable-Bond Funds Funds landing in the long-term, intermediate-term, short-term, and ultrashort bond Morningstar Categories cluster here. The funds blend government bonds, asset-backed or mortgage-backed securities, investment-grade and high-yield debt, and a modest dose of foreign bonds. Although some offerings are more income-oriented or more opportunistic than others, most provide decent exposure to a variety of bond types.

Two of Morningstar's favorites in this crowd are

"A veteran and well-resourced team, time-tested process, low expenses, and an impressive long-term track record earn Dodge & Cox Income a Morningstar Analyst Rating of Gold," says senior analyst Cara Esser. The managers invest with a three- to five-year time horizon, seeking to outperform the Barclays U.S. Aggregate Bond Index while minimizing the risk of loss. Turnover is low, yield generally exceeds those of its peers and benchmark, and duration tends to be shorter than the index.

Meanwhile, Fidelity Total Bond earns its Gold rating due to its low fees and consistently strong risk-adjusted returns. The managers don't make significant duration bets, but they do make active sector bets--usually contrarian in nature. As such, the fund can carry larger weightings in lower-quality and emerging-markets bonds than other funds in its category. Nevertheless, it has delivered over the long term.

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Despite some turmoil,

Flexible Bond Funds The multisector and non-traditional-bond fund set lands here. Like domestic taxable-bond funds, flexible bond funds can invest across a mix of bond types. Unlike domestic taxable-bond funds, flexible bond funds invest more aggressively in lower-quality paper and/or international debt. And non-traditional-bond funds, in particular, enjoy a high degree of interest-rate flexibility and may employ shorting. Simply put, these are the least-constrained bond funds.

The only mutual fund in this group to earn a Morningstar Analyst Rating of Gold is

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Government-Bond Funds The highest-quality taxable-bond funds reside in this group. To be included in one of Morningstar's U.S. government-bond categories, a fund must keep at least 90% of its assets tucked in government securities. Funds that invest strictly in Treasuries, strictly in mortgage-backed securities, or in some combination of the two populate the group. There are three government-focused Morningstar Categories included here, broken down by duration: short government, intermediate government, and long government.

Among this group,

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Corporate-Credit Funds These funds favor bonds issued by corporations. Morningstar Categories in this group include corporate-bond funds, high-yield bond funds, and bank-loan funds. Corporate-bond funds focus on bonds rated investment-grade; these funds, therefore, exhibit some degree of interest-rate sensitivity. High-yield bond funds target bonds rated below investment-grade; these funds invite more credit risk than interest-rate risk. Finally, bank-loan funds also invest in securities rated below investment-grade, and their interest payments are periodically reset. Due to their floating rates, bank loans have limited sensitivity to interest-rate movements.

A favorite here is

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On the ETF front,

World and Emerging-Markets Bond Funds The funds in this group home in on fixed-income securities issued by governments and corporations outside of the United States. That's about the only thing they all have in common. World-bond funds, in particular, must invest at minimum 40% of their assets in non-U.S. debt, but some exclude U.S. debt entirely, or focus on corporates rather than governments, or hedge currencies--or don't. Emerging-markets debt funds, meanwhile, keep at least 65% of their assets in developing-markets debt; but here, too, there are significant variations in currency strategies.

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Inflation-Protected Bond Funds As their names suggest, inflation-protected bond funds seek to protect investors from rising inflation. As such, these funds invest in securities whose principal values adjust along with the rate of inflation. However, these funds aren't impervious to changes in interest rates: They will likely suffer if rates rise for a reason other than rising inflation.

Morningstar's favorite here is Gold-rated

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Among ETFs,

Municipal-Bond Funds Interest earned on muni bonds is generally free from federal income tax and may even be exempt from state and local taxes, depending on where you live. An array of tax-free fund categories makes up this group. Some funds invest in shorter-, intermediate-, or long-term munis. Some focus on high-quality credits, while others focus on high yield. Some are even dedicated to investing in credits from particular states.

Six muni funds receive Morningstar Analyst Ratings of Gold. Four of those funds are managed by Fidelity:

"All of these funds take a relatively cautious approach that offers solid downside protection in rocky municipal-bond markets," says senior analyst Elizabeth Foos. The teams take a research-intensive approach, tapping into Fidelity's deep bench of muni-bond analysts and dedicated traders. The teams avoid interest-rate bets and instead tend to keep their durations close to their respective indexes. That said, they are willing to make some yield-curve plays, when opportunities arise. The main differences among these five funds is duration. In addition, while Municipal Income and Tax-Free Bond both invest in long-term securities, Tax-Free does not buy bonds subject to the Alternative Minimum Tax (AMT). "The combination of solid long-term records, experienced teams, and ultralow expenses earns them each a Morningstar Analyst Rating of Gold," she says.

T. Rowe Price oversees the other two Gold-rated muni funds:

Summit Municipal Intermediate manager Charlie Hill avoids riskier pockets of the muni market. "Although he'll look for value along the yield curve, Hill doesn't make big interest-rate bets either," adds Foos. Hill will, however, make sector and security plays. "A sound strategy, experienced manager team, and focus on research and quantitative analytics should serve investors well, earning the fund a Morningstar Analyst Rating of Gold."

Tax-Free High Yield is the only muni fund focusing on lower-quality credits that earns a Gold rating. Although he targets higher-yielding issues, manager Jim Murphy is cautious: He limits the fund's exposure to leveraged structures and avoids the market's riskiest names. Murphy also has the luxury of tapping into T. Rowe Price's experienced muni-bond research and quantitative teams. "Over time, the research and restraint combination has helped blunt the high-yield muni market's sharper edges, while providing superior long-term returns," says Foos.

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