Investors curious as to whether their bond funds could withstand an economic downturn would do well to look back to the last two recessions. A recession could be the last thing on the minds of income-seeking investors, who have been enjoying attractive yields on otherwise boring instruments. Consider that the six-month Treasury bill is yielding roughly 5.5%, while investors are socking away money in one-year certificates of deposit and collecting yields exceeding 5%. Stocks have also rallied going into November, with the Nasdaq Composite on pace for an eighth day of gains as investors wager that the Federal Reserve is done with its rate hikes. Still, the music is going to stop at some point. “I don’t think that a ferocious rally like this is durable, given where we still are, and even if they are done, the effects of [the hiking] are not done,” said SoFi’s head of investment strategy Liz Young on CNBC’s ” Halftime Report .” “There’s been this waiting game: Why haven’t the normal things that happen after a tightening cycle happened yet? I think it’s ‘yet’ and not ‘never.'” Investors may want to look at the bond funds that not only survived previous recessions, but also generated portfolio income while stocks were being roiled. One category stands out: intermediate core bond funds. Thriving in a slump Looking back to the Great Recession – the 2008 downturn that saw the bursting of the U.S. housing bubble, the collapse of Lehman Brothers and the failure of the Reserve Primary Fund – a handful of bond funds still offered a standout performance. The PGIM Core Bond Fund (TAIBX) and the Calvert Core Bond Fund (CLDAX ) earned returns of more than 8% from December 2007 to the end of June 2009, according to data from Morningstar Direct. Pimco’s Total Return II Fund (PMBIX) jumped nearly 8% in that period. Select members of the intermediate core bond group also managed to stand up when the Covid-19 recession struck, though the period was markedly short compared to the Great Recession. Standouts include the Carillon Reams Core Bond Fund (SCCIX) , which incurred a 7.55% return from February through April 2020, per Morningstar. The Johnson Institutional Core Bond fund (JIBFX) and American Funds’ Bond Fund of America (ABNDX) round out the top three, with total returns in that period of more than 4%. There are a few characteristics that allowed these funds to thrive and help cushion equity losses in investors’ portfolios, according to Paul Olmsted, senior manager research analyst, fixed income, at Morningstar. “When you go through these periods, those bond funds that are more interest-rate sensitive are the ones that hold up better,” he said. “You have longer duration, and when yields fall because inflation expectations are lower, you have a positive result.” Duration is a measure of a bond’s price sensitivity to fluctuations in interest rates, and issues that have longer-dated maturities also tend to have greater duration. Bond yields also move inversely to their prices, so when rates decline, investors will see price appreciation from those holdings. Indeed, TAIBX, CLDAX and PMBIX all have a duration of roughly six years. Adding duration isn’t necessarily a cure-all, however. Consider that investors have been flocking toward iShares 20 Plus Year Treasury Bond ETF (TLT) , perhaps in a bid to pick up attractive yields while prices are low. However, year-to-date total returns are -10%. The fund has a duration of about 16 years. “If you owned that at the start of the year, you’re down double-digits,” said Olmsted. A combo of attributes Core bond funds have a combination of features that prepare them for downturns. For starters, their allocations cover the entire yield curve. Being too concentrated in the short end of the yield curve subjects investors to reinvestment risk when rates come down, while being too heavily weighted in the long end could result in sharp price fluctuations when rates change. “It doesn’t take too much risk, and it’s generally diversified across Treasurys, mortgage-backed securities, asset-backed securities and corporate bonds,” said Olmsted. “There is some benefit to that for the long-term investor.” That approach also deters investors from chasing returns in riskier corners of the fixed income market. Consider that high-yield bond funds offer attractive yields exceeding 6%, but the underlying issues themselves carry default risk. Further, the bonds themselves generally have a lower correlation to “safer” assets like Treasurys and highly rated corporate bonds. As recession fears loom, the Great Recession’s top three core bond fund winners are roughly flat in terms of year-to-date returns, but Olmsted warns that it might be a better approach to focus on long-term goals and remember the role those funds play. “This is exactly when you should be in those core bonds because that income component is so much bigger than it once was,” he said.
This story originally appeared on CNBC
