(07/10/15) Total Bond: Top Team, Superior Record

In this latest issue of Fidelity Monitor & Insight, fund expert John Bonnanzio talks with Fidelity bond fund manager Ford O’Neil.

Ford O’Neil oversees an astounding $87 billion in fixed-income assets (across multiple funds).

As the primary manager of Fidelity Total Bond (FTBFX), he picks individual investment-grade bonds for the team-run fund and makes its big-picture asset allocation calls.

It’s impossible to tune out macroeconomic and political events—such as Greece as well as by Puerto Rico lately—that swirl around a fund that buys and sells government bonds.

However, it was clear from our conversation that Ford’s team won’t be distracted from making the numerous day-to-day investment decisions that ultimately drive Total Bond’s risk-adjusted returns.

That means good-old-fashioned security selection, whereby Fidelity’s massive research arm reviews the credit quality of each and every bond it buys.

So, amid this current flight-to-quality, Total Bond will be opportunistic. Says Ford: “We will look for the baby to be thrown out with the bathwater.”

It’s been tough sledding this year for most bond funds. As for Total Bond, it gained a modest 0.5% versus a decline of 0.3% for US Bond Index.

With respect to Total Bond’s positioning, it—and all other Fidelity bond funds—must be duration-neutral, meaning they can’t make significant bets on interest rates relative to their benchmarks.

In Total’s case, duration is about five years. This suggests that a one-percentage point rise in rates would send the fund down 5%.

In an effort to mitigate that risk (it can’t be eliminated), Ford has barbelled Total’s holdings, meaning that it owns lots of short-term bonds with maturities of two to three years, very few at five to seven years, and some longer-term notes of ten to 20 years.

Ford’s strategy of overweighting corporates at the expense of risk-free Treasuries (credit-wise) is a crucial bet. Whereas the fund’s benchmark has 24% in corporates and 37% in Treasuries, Total essentially flips that around: 44% versus 27%.

Here’s another way to view a slice of Total’s credit risk: 39% of its assets are in bonds rated A and BBB versus 22% for its benchmark. And mortgage-backed securities are a considerable underweight at 13% versus 24%.

So, where are those superior bonds (in terms of risk versus reward) hiding? As its turns out, in a number of areas, says Ford, including some that are admittedly less liquid.

He’s upped the fund’s allowable out-of-benchmark allocations to about 20% from the more usual 15%. This includes high-yield (7%), floating-rate (5%), and even emerging market debt.

While Total Bond never chases yield via interest-rate bets, it does strive to pick up incremental income by striking an appropriate balance of risk and reward.

Diversification, coupled with Ford’s superior track record and a team of specialists, warrants our Buy rating and the fund’s inclusion in our model portfolios.