3 Bond Fund Buys for a Low Rate World

10/02/2020 6:00 am EST

Focus: BONDS

Richard Moroney

Editor, Dow Theory Forecasts

Can it get any worse for bond investors? The benchmark 10-year Treasury yields a paltry 0.7%, down from 1.9% at the start of year, observes Richard Moroney, editor of Dow Theory Forecasts.

The 30-year bond pays 1.4%, well below the 25-year average of 4.4%. Don’t look for much improvement soon. The Federal Reserve is expected to keep its key target short-term interest rate near zero through 2023.

Many subscribers holding cash are looking for safe havens. While Treasuries still deserve a place in conservative portfolios, there are better options for yield-hungry investors willing to take on slightly more risk. Below, we profile three Forecasts recommended funds to boost your income.

Vanguard GNMA (VFIIX), which has a 12-month trailing yield of 2.1% and SEC yield of 1.4%, invests in mortgage securities backed by the full faith of the U.S. government.

12-month trailing yield evaluates a fund’s historical income stream, while SEC yield is more forward looking. Ginnie Mae (GNMA) securities earn the highest credit quality yet typically offer higher yields than Treasuries to compensate for a unique risk — that homeowners pay off their mortgages early.

When rates fall and refinancing activity accelerates, mortgage-backed bonds are paid off more quickly, forcing investors to reinvest at lower yields. Conversely, refinancing slows when rates climb. Rock-bottom mortgage rates have triggered a wave of refinancing that has weighed on recent performance.

Vanguard GNMA has returned 3.1% in 2020, compared to 5.6% for the average government bond fund. That said, Vanguard GNMA offers an attractive, low-risk alternative to Treasury funds. The fund has declined once since 2005 — a 2.2% dip in 2013. Its annual expense ratio is 0.21%.

With a trailing yield of 2.5% and an SEC yield of 1.0%, Vanguard Short-Term Investment Grade (VFSTX) is an excellent choice for safety, reflecting its diversification and strong track record.

Holding roughly 2,400 high-quality securities, the fund focuses on corporate bonds but also invests in mortgage-backed securities and foreign bonds.

The portfolio holds bonds maturing on average in 2.9 years. A bond’s interest-rate risk increases with time to maturity; short-term bonds tend to hold their value better when rates rise.

Up 4.3% so far in 2020, Vanguard Short-Term lost money in just one of the last 15 years — a 4.7% loss in the credit crunch of 2008. The fund has an expense ratio of only 0.20%. At 3.4%, its 15-year annualized return outstrips the category average of 2.8%.

Investors who can take on additional risk to boost income and return should consider Baird Core Plus Bond (BCOSX). With a trailing yield of 2.3% and an SEC yield of 1.4%, the fund is 54% invested incorporate bonds.

To help control risk, Baird Core holds more than 1,500 bonds diversified across a variety of issuers and sectors. Portfolio duration of 5.9 years gauges the expected percentage change in share price in response to a change in interest rates of one percentage point.

Baird Core has eight portfolio managers, with six on staff since its inception in 2000. Up 7.3% so far in 2020, the fund has lost money four times since 2005, including a 2.1% decline in 2008. The expense ratio is a reasonable 0.55%.

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