The Fed’s 2018 tightening cycle hurt most bond funds and made floating rate funds better performers explains fund expert Jack Bowers, editor of Fidelity Monitor & Insight.
Interest rate hikes in 2018 by the Federal Reserve were the bane of bond funds, especially those with longer maturities. In fact, many funds’ total year-end returns were less than their SEC yields, meaning that they experienced a capital loss.
For example, U.S. Bond Index fund yielded 2.44% at the start of the 2018, but it returned 0.0% for the year. The Long-Term Treasury Index fared even worse: its yield started at 2.58%, but it returned -1.6% for the year.
One response to this challenging rate environment was to buy Floating Rate High Income (FFRHX) for our Income Model.
Although the move followed a March rate hike, there were three more to come. Whereas that was a headwind for most bond funds, Floating Rate’s yield adjusts up and down (with some lag) with interest rates.
Of course, the fund has a significantly higher yield than a fund with comparable rate-risk (such as Conservative Income Bond) because its portfolio of leveraged floating rate bank loans are of a low quality.
That became a problem during the fourth-quarter selloff, and Floating Rate finished 2018 flat. This year, however, Floating Rate has already returned 5.7%. But its opportunities may be limited.
While corporate earnings are holding their own and credit defaults are largely unchanged, the lack of a trade deal increases the odds of a rate cut, or several. As such, we’re watching Floating Rate closely. But for now, there’s no need to make a change.
