These Bond Funds Have Provided Effective Ballast

Although the market turned around a bit on Tuesday, the past year has tried investors' patience. Investors in search of bright spots in their portfolios won't find many. Some of the traditional diversifiers for U.S. equities have fizzled, while others that have performed well don't yet appear in many investors' portfolios.

Precious-metals equities have surged recently, but they're still well in the red over the past year. Commodities' performance has been even more abysmal. Bear-market funds, which generally bet against stocks, have performed well--no surprise there. But they're volatile, and the fact that stocks trend up over long periods of time makes them a bad long-term bet. Managed-futures funds have performed well, as discussed here, but they're still a niche category; most investors don't own them at this point, and their often-high costs should give everyone pause.

Instead, the lone bright spot in most investors' portfolios has probably been bonds--specifically, high-quality bonds like Treasuries, high-quality corporates, and municipal bonds. While some bond-fund types have lost money because their performance pattern syncs up with equities as much as bonds--I'm looking at you, high yield and emerging markets--many high-quality portfolios have landed in the black. In so doing, they've proven yet again that investors don't have to range far and wide--or pay an arm and a leg--for diversification. The simplest diversifier is often the best diversifier.

To help shine a light on bond funds that Morningstar likes that have distinguished themselves during this recent equity-market shock, I screened our database for core bond funds with Morningstar Analyst Ratings of Silver or better that managed positive returns during the past year, a period in which the S&P 500 has dropped about 9%. I included both taxable- and municipal-bond funds, the latter of which will be the better bet for many investors' taxable portfolios.

Note that many of these funds have long durations. Having above-average interest-rate sensitivity has helped hold them aloft when equities have fallen; interest rates often decline in such periods, boosting the fortunes of longer-term bonds. But long-term bond funds typically have much higher volatility than their intermediate-term counterparts and could prove vulnerable if interest rates trend up during the next five to 10 years. Long-term bonds are tough to avoid in the municipal-bond space, because much of the issuance is long dated, but investors will certainly want to have a longish time horizon of 10 years or more if they hold them.

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to view the screen or adjust it to suit their own parameters. Here's a closer look at a few of the funds that made the cut.

Morningstar's manager-research analysts have long put Fidelity's operation at the top of the muni-bond heap, and this fund is one of the best core offerings from the shop. Fidelity veteran Mark Sommer leads a three-person team here; senior analyst Beth Foos points out that the team has experience with credit analysis, trading, and quantitative research. As with Fidelity's muni operation at large, this fund is managed conservatively: Its typical performance pattern is to lag during big credit rallies while holding its ground when the muni market sells off. In 2008, for example, its 1% gain placed it in the top 20% of the muni-national intermediate group.

Like several other top intermediate-term bond funds, this one emphasizes mortgage-backed bonds, which causes it to look quite different from its typical peer and the Barclays U.S. Aggregate Bond Index. Senior analyst Cara Esser notes that management typically allocates between 40% and 65% to mortgage-backeds. The fund is managed with an eye toward the downside and tends to lag its peers when credit-sensitive bonds rally; management avoids junk bonds and interest-rate bets, and often holds its bonds until maturity. The fund's longtime lead manager took a leave of absence in late 2015, but Morningstar's analysts maintained the fund's Silver rating. They're confident in new manager Barb Miller as well as the team backing her.

Several Vanguard funds, both taxable and muni, made the cut in our screen. Their unifying theme? Ultralow costs, which help ensure that the funds can deliver competitive yields and total returns without having to delve into lower-quality or otherwise-risky bonds. This fund, which tracks the Barclays Aggregate U.S. Float-Adjusted Index, has come in for some criticism because the index includes such heavy exposure to the government sector. But as I discussed in this article, government bonds are among the most steadfast diversifiers for equity portfolios, typically gaining more than other bond types in equity-market shocks.