Bower’s Bond Bets

03/22/2016 9:00 am EST

Focus: FINANCIALS

Jack Bowers

Editor, Fidelity Monitor & Insight

With investors largely unconcerned about inflation, yet clearly anxious about the pace of growth in the US and abroad, it’s little surprise that bonds have been faring quite well this year, observes Jack Bowers, editor of Fidelity Monitor & Insight.

In particular, safe-harbor Treasuries have shown themselves to be great portfolio diversifiers.

So far this year, our more conservative model portfolios have benefited from bonds generally, and through Fidelity Spartan Total Bond (FBIDX) in particular.

Last year, Total Bond modestly trailed its benchmark for the same reasons it is today: an underweight in strong-performing (though expensive) Treasuries and an overweight in lagging high-yield corporate bonds.

But in absolute terms, the fund’s 36% stake in US government bonds (including Treasury and other US agency debt such as mortgage bonds) has still been Total Bond’s performance-driver.

This has helped it to gain a decent 1.1% this year. Most importantly, the fund’s presence in our models continues to reduce overall portfolio risk and contribute to their income.

Meanwhile, high yield bonds have been hit harder than the stock market over the past year, mainly because debt service concerns in the energy sector have caused lenders to become more cautious on all fronts.

While energy sector fears are well founded (the trailing 12-month default rate is already approaching 10%), most other high-yield borrowers are in relatively good shape.

In recent years, Fidelity has been conservative in the management of its high-yield bonds funds, and in the recent selloff most of their funds had adequate cash and were underweight energy and mining issues.

As a result, Fidelity Capital & Income (FAGIX), Fidelity Focused High Income (FHIFX) and Fidelity High Income (SPHIX) have only been about half as risky as the S&P 500.

At the same time, Fidelity Floating Rate High Income (FFRHX) has only been about one-fifth as volatile.

While there is some risk that the high-yield default rate will worsen, investors who jump in now have a decent shot at enjoying not only a robust income stream, but also some capital appreciation as today’s uncertainty declines.

The potential exists for some high yield funds to outperform the S&P 500 over the next 12 months.

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By Jack Bowers, Editor of Fidelity Monitor & Insight.

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