Bonds Are Getting Hit. What to Do? Morningstar Has Ideas.

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Bonds have spit the bit in recent months, with raging inflation and Federal Reserve interest-rate increases sending yields soaring.

The Bloomberg U.S. Aggregate Bond Index has slumped 12% year to date. So what’s a bond-fund investor to do? 

It has more to do with spending needs than interest-rate trends, says Christine Benz, director of personal finance for Morningstar.

If you’re going to need that money in the next six to 10 years, intermediate-term core bond funds are the place to be, she says. But if it’s three to five years, think about short-term bond funds.

You always want investment funds with low fees, but that’s particularly important with short-term bond funds, as your returns already are low by definition, Morningstar notes.

Here are the firm’s favorite short-term bond mutual funds and exchange-traded funds. All of them have Morningstar’s highest rating of gold.

  1. Baird Short-Term Bond BSBIX
  2. PGIM Short-Term Corporate Bond PSTQX
  3. Vanguard Short-Term Corporate Bond  (VSTBX) – Get Vanguard ST Corp Bond Index Inst Report VCSH
  4. Vanguard Short-Term Treasury  (VSBSX) – Get Vanguard ST Treasury Index Adm Report VGSH

Baird Short-Term Bond: The fund’s “no-nonsense approach focuses on investment-grade corporates, high-quality securitized credit, and government bonds,” Morningstar analyst Gabriel Denis wrote in a commentary.

“The process forgoes leverage, derivatives, and macro trades, while its duration-neutral style allows management to focus on security selection and sector rotation.”

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Further, “though the team’s long-term record is middling relative to aggressive peers in the short-term bond Morningstar Category, its circumspect approach has generally worked in the strategy’s favor in stressful markets,” Denis said.

PGIM Short-Term Corporate Bond: “The [fund’s] strategy is atypical for a short-term bond offering,” Morningstar analyst Eric Jacobson wrote in a commentary. “It has generally kept its duration between 2.6 and 2.8 years. That can look long for the peer group, which recently averaged roughly 2.0 years of duration.”

Further, the fund “places an unusually heavy focus on corporate debt — and associated greater exposure to A and BBB issues,” he said. “Unsurprisingly, it has lagged its peers at times … in which its above-average credit or interest-rate risk hurt.”

But “its long-term record remains strong versus the short-term bond Morningstar category,” Jacobson said.

Vanguard Short-Term Corporate Bond: “The fund replicates the Bloomberg U.S. 1-5 Year Corporate Bond Index, which includes U.S. investment-grade corporates. … The index is market-value weighted,” Morningstar analyst Neal Kosciulek wrote in a commentary.

“A passively managed, market-value weighted index fund is a solid option for exposure to the short-term investment-grade corporate market,” he said.

“Market-value weighting helps the fund accurately capture the risk/reward characteristics of its opportunity set by using the market’s collective wisdom about the relative value of each of its holdings to size its positions.”

Vanguard Short-Term Treasury: “The fund tracks the Bloomberg Barclays U.S. Treasury 1-3 Year Index, a market-value-weighted index,” Kosciulek wrote in a commentary.

“Expectations for … inflation and interest rates are quickly baked into the prices of Treasuries,” he said. “It is difficult for active managers to gain a durable edge … in this market without taking greater risk than the tiny amount present in this fund’s portfolio.”

Further, “this fund ranks among the cheapest in its category,” Kosciulek said.