The Year in Bond Funds

After a banner year for the investment-grade U.S. bond market in 2014, 2015 yielded decidedly anemic results. Through Dec. 21, 2015, the Barclays U.S. Aggregate Bond Index had gained just 0.80% for the year to date. That flat return obscured a fair amount of volatility in the broader bond markets, however, and many Morningstar Categories fared far worse. Notably, the high-yield bond category, down 4.9% for the year to date, was on pace to suffer its first annual loss since 2008.

With that in mind, we take a look at the biggest bond fund stories of 2015.

Fed Watch All eyes were on the Fed in 2015 as it approached its first planned rate hike since 2006. The Fed finally delivered after its Dec. 16 meeting, raising its target federal-funds rate by 25 basis points.

The Fed only directly controls short-term rates, however, and history suggests that what happens to the rest of the bond market in the wake of a fed-funds shift depends on a number of other factors. Since the end of 2014, other short-term rates have risen noticeably in line with market expectations of a rate hike, but long-term bond yields are close to where they started the year. (Check out the U.S. Department of the Treasury's nifty Treasury Yield Curve chart to see how the yield curve has evolved over time.) As a result, while funds in the rate-sensitive intermediate-term government category have seen only meager returns for the year to date through Dec. 21, most of its funds are still in the black for the year to date.

A Fund Closure and an Energy-Driven Rout in the High-Yield Markets The abrupt closure of Third Avenue Focused Credit in early December drew investor attention to the struggling junk-bond sector. It is unlikely that other high-yield funds will follow in Third Avenue's footsteps: That fund stood out for its focus on distressed credits and concentrated positions. It was still a painful year for high-yield investors overall, though, as a rout in oil and other commodity sectors spelled trouble for junk-rated companies in the energy and metals and mining sectors.

As my colleague Sumit Desai predicted early in 2015, how a manager approached the energy sectors turned out to be a big driver of success or weakness over the course of the year.

A Strong Dollar Dominates The other way for bond funds to lose money in 2015 was via the currency markets. The U.S. dollar logged big gains against both developed-markets--including the euro and Canadian dollar--and emerging-markets currencies. Brazil's government debt was downgraded to junk status amid continued fiscal woes, and the Brazilian real was one of the world's worst-performing currencies.

So, while funds fully hedged back to the U.S. dollar, such as

The Barclays U.S. Aggregate Bond Index – A Hard Benchmark to Beat For the second year running, the Barclays U.S. Aggregate Bond Index proved a worthy adversary. Through Dec. 21, the broad fixed-income benchmark's 0.8% gain landed it well ahead of the 0.2% return for the median fund in the intermediate-term bond category.

The winners among that group in 2015 included

With the aforementioned sell-offs in the high-yield and foreign-currency markets, some of the category’s riskiest funds had a particularly rough year. Loomis Sayles’ two entrants in the category,

A Quiet Year in the Muni Market Amidst a turbulent year for the taxable-bond universe, the muni markets were a relative bright spot. Aside from Puerto Rico's much-publicized troubles, the picture for muni credit remained relatively strong. A benign supply and demand environment as well as limited exposure to trouble among global economies and commodity markets also helped shield municipals. The typical fund in the muni national long Morningstar Category was up 2.9% for the year to date through Dec. 21, 2015. Healthcare-related bonds fared particularly well, helping funds with overweightings to that sector, including T. Rowe Price Summit Municipal Income PRINX, turn in solid returns.

Unlike their taxable cousins, high-yield munis had a particularly strong year, with the tobacco sector leading the way. That helped propel funds such as