What Bond Funds To Buy Now
Historically, bonds have offered shelter for portfolios when financial storms touch down on Wall Street. But bonds have not been a haven this year in the grip of surging inflation and fast-rising interest rates. Instead, fixed-income assets ranging from U.S. Treasuries to higher-yielding "junk bonds" have logged double-digit-percentage losses resembling declines suffered by more-volatile stocks.
what bond funds to buy now
Bond experts have been surprised by the swift and steep drop in bond prices, causing yields, which move in the opposite direction, to spike sharply higher. "No, it's not normal at all," says Andy McCormick, head of global fixed income at fund company T. Rowe Price.
But amid all the gloom in bond-land, there are rays of sunshine peeking through the clouds, says LPL's Gillum. "We think the worst is behind us," he says. The valuation and yield on all types of bonds, he says, look much better today than at the start of the year.
Just as stocks go on sale in a bear market, bonds have moved from the full-price aisle to the discount bin. That doesn't mean rates can't move even higher if inflation stays hot. But keep in mind that the forward-looking bond market has already pushed interest rates significantly higher to account for coming Fed increases. "Markets have already priced in a pretty bad scenario," says Elaine Stokes, executive vice president and portfolio manager at investment firm Loomis Sayles.
If you're eyeing even more income, high-yield bond yields recently hit 8.5%, compared with 4.35% at the end of last year; corporate bond yields hit almost 5%, versus 2.35%, according to ICE/Bank of America indexes tracked by the St. Louis Fed. The yield on the Agg is now nearing 4%, up from 1.75%. The higher yields, which provide some cushion if bond prices dip further, spell opportunity for investors whose portfolios now have low weightings in bonds.
Higher yields make the starting point far more attractive for investors who are putting new money to work, says Mary Ellen Stanek, co-chief investment officer and bond fund manager at money management firm Baird Advisors. "The higher yields going forward are pretty powerful," says Stanek. They "may just be the retirement gift that boomers have been looking for."
That murky outlook is why Michael Fredericks, manager of BlackRock Multi-Asset Income fund, is not advising investors to bet on bonds "with all your chips" just yet. Stokes, of Loomis Sayles, offers this advice: "I wouldn't go all-out. I'd start tiptoeing in."
Conservative investors should consider short-term bond mutual and exchange-traded funds, which are less sensitive to future interest rate increases and now sport plump yields. "If yields of 3% to 3.5% are what you're looking for, short-term Treasuries have become a lot more attractive," says Stokes. And with shorter-term corporate bonds, "the default risk is very low," says Fredericks.
Spread your bets around, the bond pros say. And stick with high-quality and short- to intermediate-term bonds (ones that mature in three to 10 years) that offer competitive yields with less credit and interest rate risk than dicier fare, says Rob Haworth, senior investment strategist at U.S. Bank Wealth Management.
With more volatility expected, given the uncertain outlook, a good strategy is to invest in a diversified fund benchmarked to the broad Agg index, which includes investment-grade U.S. Treasuries, corporate bonds and mortgage-backed securities. "Higher-quality corporates and U.S. Treasuries can withstand economic distress," says Haworth.
The Baird Aggregate Bond (BAGSX (opens in new tab), 3.44%), a team-run fund that takes a disciplined, long-term approach that eschews big bets, is a good choice. The fund's 1.79% annualized gain over the past 10 years has outpaced 82% of its peers, according to fund tracker Morningstar. At last report, nearly 60% of the fund's assets were invested in AAA bonds, with corporates making up the biggest part (39%) of the portfolio. Passive investors might like the iShares Core U.S. Aggregate Bond ETF (AGG (opens in new tab), $101, 3.28%), which has a low expense ratio of 0.03%.
The Fidelity Intermediate Municipal Income (FLTMX (opens in new tab), 2.55%) is a member of the Kiplinger 25, the list of our favorite actively managed mutual funds. It has bested 86% of its peers in the past year. The fund has a tax-adjusted yield of 4.05% for someone in the 37% bracket and 3.36% for a taxpayer in the 24% bracket.
Investors willing to take on more risk to earn fatter yields should consider high-yield bonds, issued by firms with less-than-stellar financials, says BlackRock's Fredericks. If the consensus view is correct that a recession, if we get one, won't be severe, it's unlikely junk bonds will see a big increase in defaults, which takes some risk off the table. Fredericks says investors are receiving ample compensation for the risk, given that the average junk-bond yield has more than doubled since the start of the year. A solid choice is the Vanguard High-Yield Corporate (VWEHX (opens in new tab), 6.66%), a Kip 25 member as well as a top Morningstar pick for "cautious high-yield bond exposure."
To capitalize on rates that could move even higher, Fredericks recommends bank-loan funds that own floating-rate debt. If rates go up, you'll earn a higher yield on the loans. The T. Rowe Price Floating Rate (PRFRX (opens in new tab), 4.43%), a member of the Kiplinger 25, is a good choice.
Historically, bonds have always acted as a kind of "ballast" for portfolios. During market crashes like those in 2008 and March 2020, bonds, especially high-quality ones like U.S. government Treasurys, soared in a "flight to safety." This was due to the Federal Reserve slashing interest rates and implementing quantitative easing, which boosted the price of fixed-income assets. Although this changed in 2022 when interest rates rose sharply and caused bonds to sell off alongside equities, 2023 might be shaping up to be a better year for bonds. This is because bond yields have started the year at a much higher level. This can potentially help bonds become a viable income-generating asset once again. To get around the lack of liquidity and complication of buying individual bond issues, consider using a low-cost bond exchange-traded fund, or ETF. Here are the nine best bond ETFs to buy right now.
A popular low-cost buy-and-hold fund for long-term investors is BND, which offers broad exposure to the U.S. bond market. By tracking the Spliced Bloomberg U.S. Aggregate Float Adjusted Index, BND provides access to over 10,000 government, agency and investment-grade corporate bonds. The ETF currently provides a weighted-average yield to maturity, or the interest an investor earns when holding the bond until it matures, of 4.3% along with an intermediate average duration of 6.6 years. Should interest rates rise by 1%, BND can be expected to lose 6.6% in value, all else being equal. The opposite will occur if rates are cut. Bond price and yield move inversely: when one goes up, the other goes down. BND's most notable feature is its low expense ratio of 0.03%, or about $3 annually per $10,000 invested.
No matter what the market is doing, however, investors need bonds to bolster a well-diversified investment portfolio. Fixed income provides ballast because this asset class is less volatile than stocks. As interest rates continue to rise, bond ETF investors will be rewarded with higher yields, which is what income investors want.
As with any bond investment right now, you should be prepared for shorter-term pain due to rising interest rates, but over the long term, LQDI is designed to smooth out the negative effects of inflation. During the prior two and four years, the fund has handily outperformed the Bloomberg Barclays U.S. Corporate Bond Morningstar category index.
Global bonds are known for delivering high yields, and the Vanguard Total International Bond ETF gives you global yields at a rock-bottom price. The fund tracks the Bloomberg Global Aggregate Ex-USD Float Adjusted RIC Capped Index, a benchmark to minimize the impact of currency market fluctuations.
High-yield bonds give you greater yields in exchange for more risk. The iShares Interest Rate Hedged High Yield Bond ETF enlists a strategy similar to LQDI, its corporate bond sibling. HYGH owns shares of the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) and adds short positions in interest rate swaps. Returns are benchmarked against the BlackRock Interest Rate Hedged High Yield Bond Index.
The portfolio includes mostly intermediate-term bonds concentrated in the BBB- to BB-rated category. Yields should rise hand-in-hand with higher interest rates. HYGH is best for fixed-income investors with lower-quality debt and slightly elevated risks.
SHM owns more than 1,000 bond issues, 20% of which are from the state of California, 17% from New York and 9% from Texas. Investors in these states may exempt a proportion of their income from state taxes.
The initial screen yielded 101 bond funds, which we sorted based on each category above. The funds we selected for further study hewed toward intermediate to short maturities. We avoided long-term bond funds, which are likely to suffer during forthcoming rounds of interest rate hikes.
The remaining contenders were individually screened for their ability to maintain reasonable average five-year returns in the face of rising interest rates. We also looked at yields, and estimated the likelihood of category-beating performance in the current economic environment. From that list we culled a diversified list of seven bond ETFs suitable for a range of fixed-income investors.
As bonds reach maturity over time, companies and governments sell investors higher-yielding new issues. But short-term bonds are closer to that day than longer-term bonds, making investors more interested in holding them than longer-term bonds.
And you might be surprised to learn that during prior periods of rising interest rates, total bond returns were quite favorable. Bond ETF owners should focus on cash flow during the next year or so until bond prices stabilize. 041b061a72