Bond Funds Have Mixed Returns In March And Q1

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Best Mutual Funds 2015:First-Quarter Performance Report

W hile bond fund investors may be jittery ahead of this year's expected interest rate hikes, many in the financial circles forecast the Federal Reserve's actions to be more cautious or paced than what they've been in the past.

Part of the reason may be that economic data still show mixed results. March's employment report showed that the U.S. created 126,000 nonfarm jobs, according to the U.S. Department of Labor, making it the lowest increase in 15 months. By way of contrast, jobs grew an average of 269,000 a month in the previous 12 months.

In addition, U.S. economic growth is now expected to come in closer to 2% to 2.5% vs. 3%, according to various projections.

The changes increase the challenges for investors seeking top performing mutual funds . "The growth forecast has been adjusted down, so the bond market remains in a positive tone," said Ben Emons, senior vice president and portfolio manager at Pimco. "For that matter, the Fed will not tighten any time soon and may not tighten until later this year, possibly around September."

Bond Yield Curve Flattens

As a result, bond markets did well in March, with the longer-end outperforming shorter-maturity bonds, as the yield curve flattened.

Bond funds had spottier returns. Short U.S. Treasury funds ticked up 0.11%, lifting their first-quarter gain to 0.27%, according to preliminary mutual fund data gathered by Lipper. Intermediate U.S. government funds rose 0.47%, hoisting their Q1 gain to 1.23%.

But Treasury Inflation Protected Securities, or TIPS, fell 0.6%, trimming their Q1 gain to 1.01%.

Longer-maturity general U.S. Treasury funds gained 0.78% in the month, which brought their Q1 return to a fixed-income leading 2.40%. Among investment-grade corporate bond funds, A-rated funds picked up 0.33% in March, putting the finishing touch on a 1.93% Q1 gain. BBB-rated investment-grade funds rose 0.24% for the month and 2.07% in Q1.

World income funds ended 0.54% lower for the month and flat for the quarter. Among them, international income funds gave up 1.20% for the month and 1.60% for the quarter.

The big news was the European Central Bank's start of quantitative easing. The ECB's plan is to buy government bonds and securities from European institutions and national agencies between now and September.

The dollar's strengthening against other major currencies as a result of the ECB's program hasn't helped investors when their nondollar gains are translated back into dollars, though a mid-March pullback eased the pain.

Another effect of ECB's quantitative easing is declining yields in the U.S. as investors have been going after more yield outside the eurozone.

Taking into account all the factors, Emons expects the Fed to proceed cautiously, taking into consideration all data before making any decisions.

Going forward, Emons expects higher volatility in the front-end of the yield curve, due to the uncertainty of the path of those short-term interest rates. TIPS should gradually benefit, especially if inflation starts to gradually tick higher.

Other positive fixed-income areas include U.S. non-Agency MBS bonds and European bonds.

"As the housing market continues to be in a slow recovery mode . .. non-Agency MBS bonds remain quite favorable," he said. This is because the quality of the underlying borrowers continues to improve with the job market advances, while at the same time the underlying collateral is slowly appreciating, he explained.

In Europe, demand for fixed income is strong, which can provide more upside potential, especially in intermediate- to long-term bonds.

High-Yield Funds

In the high-yield markets, March saw increased flows both in the U.S. and internationally. That said, high yield is not expected to do as well as in the past.

"The energy market really upset the high-yield market," said Fran Rodilosso, senior investment officer for Van Eck's Market Vectors fixed-income exchange traded funds. But he doesn't expect many defaults to hit the market,as the overall risk in the sector has declined.

The municipal bond market marked small advances in March, with muni funds advancing an average of 0.20%, putting their Q1 gain at 0.89%. "Munis continue to face very strong and relatively consistent demand from the shareholder side," said Jim Grabovac, managing director and senior portfolio manager at McDonnell Investment Management.

"The other thing that has occurred this year has been an increase in supply. As rates have come down pretty dramatically last year, refunding issuance has picked up sharply in the muni market," he said. But he doesn't anticipate the same pace to continue for the rest of 2015. Muni sectors that should continue to do well are hospitals, higher education and transport.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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