Treasuries Were Bond Mutual Fund Bright Spot In Q3

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Best Mutual Funds 2015:Q3 Performance Report

T he Federal Reserve and the fixed-income markets had one theme in common in September: Both had no appetite for risk.

The Fed decided not to raise its benchmark interest rate on Sept. 17, on the back of the devaluation of the Chinese yuan, global deflationary pressures and somewhat mixed results in the U.S. economy.

"The Fed didn't raise rates for one reason and one reason only," said Jennifer Vail, head of fixed-income research and U.S. Bank Wealth Management. "And that is: The Fed, historically, does not traditionally begin to normalize policy during a market dislocation. And we were truly experiencing a market dislocation."

That decision was reflected in the stock and bond markets . Rates rose prior to the FOMC meeting, with the 10-year Treasury yield reaching as high as 3.08% on Sept. 16. The yield curve had slightly steepened by then. But by the end of September, yields had fallen across the board and the 10-year finished at 2.87%.

General U.S. Treasury mutual funds were up 1.22% for the month, 3.02% in Q3 and 1.09% for the year, according to preliminary Lipper Inc. data. GNMA funds also did all right, gaining 0.36%, 0.43% and 0.77% for the respective periods. Treasury Inflation Protected Securities ( TIPS ) ended September down 0.88% with declines of 1.92% for Q3 and 1.81% year to date. Short U.S. Treasury funds ended the month up 0.19%, which lifted them to gains of 0.35% for Q3 and 0.95% year to date. Intermediate U.S. government funds were up 0.65%, 1.18% and 1.31%.

Investment-grade corporate bond mutual funds did relatively well up to the last week of September. A-rated funds were up 0.47% for the month and 0.68% for the quarter, but down 0.27% year to date. BBB-rated funds were up 0.17% in September, but down 0.06% in Q3 and 0.96% year to date.

High-yield funds, acting more like stocks , sank 2.42% in September, 4.48% in Q3 and 2.30% this year. Hard-currency emerging-market debt funds benefited from a stronger dollar, as these funds fell 2.22%, 4.75% and 3.61%. Local-currency emerging market debt funds fell 3.45%, 10.06% and 13.76%.

"The picture for investors isn't getting any easier," said Dave Mazza, head of research of SPDR ETFs and SSGA Funds at State Street Global Advisors. Add to the mix some fairly hawkish statements and "all this is doing is leading to an uncertain backdrop for rates and then that feeding through to all other areas of the bond market."

High Anxiety For High Yield

An area that continues to have some negative fallout is the high-yield space, he said. "Sentiment has turned particularly negative.... If we take a step back and look at the weakness in high yield, corporate fundamentals, other than energy, remain very strong."

So what's a fixed-income investor to do going forward?

"It looks like the Fed may raise rates in December," said Tony Crescenzi, executive vice president and strategist at Pimco. While he expects the yield curve to flatten some in such a scenario, the global demand for U.S. bond market yields will keep those from rising in a significant way. Crescenzi prefers the intermediate part of the yield curve as opposed to the long end.

Volatility in the credit markets should provide opportunities for investors . Areas that Crescenzi likes are housing, consumer goods, telecom, financial institutions, health care, non-agency mortgage-backed securities and European banks. Investors should avoid the energy sector and be very careful and selective with emerging markets.

Avoiding Short-Term Issues

Vail also says to avoid the short-term bond market. "That sounds a little counterintuitive going into a normalization of policy, but because this trajectory of normalization is going to be so much shallower than previous cycles, clients won't be able to immediately reinvest their shorter maturities at much higher rates."

An area that is poised to provide lower volatility and some positive returns are municipal bond mutual funds, says James Colby III, senior municipal strategist and fund manager at Van Eck Global.

In September, most municipal bond funds had modestly positive returns, with the intermediate funds advancing 0.50%. Year to date, state muni funds scored an average return of 1.18%, getting a boost from a 1.30% Q3 gain.

"What is clear is that, like in our history, the volatility was significantly less (in munis) than in other asset classes," he said. "The relative value of that, is that on a risk-adjusted basis ... munis are very favorable."

Because the market has been somewhat overlooked by investors this year, it provides slightly higher yields. In addition, its true value lies in the very high-quality asset class that it is. He especially likes the muni high-yield sector, as well as states such as California and Massachusetts.

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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