Signals from the economy and hints from the Federal Reserve show compelling evidence that a an interest-rate hike is somewhere in the nebulous “near” future.
Thus, even though the when of higher interest rates isn’t exactly set in stone, now would be a good time to make sure you’re in at least one of the best fond funds for tackling rising interest rates.
American paychecks are growing, we’re getting close to full employment, inflation data is where the Fed wants it to be, oil prices have stabilized and the U.S. dollar has stopped appreciating.
This all sets the stage for a green light for rising interest rates within a matter of months, especially if the next couple of months’ worth of employment and economic-growth data continue along the same lines.
Now, investors should note that this won’t exactly mean Armageddon for the decades-long bull market in bond prices, but there’s no doubt that the fixed-income environment will be different, and that’s what counts.
So, with that in mind, here are three of the best bond funds for a new reality of higher interest rates.
Best Bond Funds for Rising Interest Rates: Vanguard Total Bond Market Index (VBMFX)
Expenses: 0.2%, or $20 for every $10,000 investedLoad Fee: None
Vanguard Total Bond Market Index (MUTF:VBMFX) just became the world’s biggest bond fund for a good reason: It’s an outstanding diversified, low-cost, passively managed fund.
Prices on long-term bonds can be more risky when rates are rising, but yields on shorter maturities aren’t likely to pop anytime soon. Therefore, a well-diversified fund like VBMFX can be a great middle-of-the-road fund to balance interest-rate risk with maintaining decent yields.
With that said, passively managed bond funds can fall behind actively managed peers in transitional economic environments because the index fund manager can’t shift holdings to take advantage of trends — they simply track an index.
So whether you buy VBMFX comes down to what type of investor you are and what you’re looking for. If you’re long-term-minded and you’re looking for diversity for a low cost with an eye not toward beating the market, just not losing to it … well, Vanguard Total Bond Market Index is right for you.
And you don’t get much cheaper than Vanguard Total Bond Market Index Fund Investor Shares, which charge a pittance at 0.2%.
Best Bond Funds for Rising Interest Rates: Metropolitan West Total Return Bond (MWTRX)
Expenses: 0.62%Load Fee: None
If you are looking for an actively managed bond fund that has a management team with the experience and skills necessary to navigate challenging fixed-income environments, Metropolitan West Total Return Bond Fund Class M (MUTF:MWTRX) may be the fund for you.
There is a good reason that MetWest Total Return has been one of the biggest beneficiaries of outflows from Pimco Total Return Fund (MUTF:PTTRX) since Bill Gross’ exit last year. The management team — consisting of Stephen M. Cane, Laird R. Landmann, Bryan Whalen and Tad Rivelle — have been leading the fund for 18 years and have put up a stellar track record in that time.
Their MWTRX portfolio has outperformed the average intermediate-term bond fund in nine of the past 10 calendar years, outperforming 98% of the category for 10-year annualized returns.
The management has room to shift holdings from two to eight years in duration and can hold up to 20% of assets in below-investment grade bonds. Currently, the credit quality of the fund’s holdings averages at investment grade (BBB).
This flexibility and long-term track record make for a sound choice in any environment.
Best Bond Funds for Rising Interest Rates: T. Rowe Price Floating Rate Fund (PRFRX)
Expenses: 0.86%Load Fee: None
If you’re looking for a bond fund that can perform reasonably well amid rising interest rates, T. Rowe Price Floating Rate Fund (MUTF:PRFRX) is a solid choice.
Also called bank loans, floating-rate notes or “floaters,” floating-rate bonds adjust on a regular basis and the respective interest rate is tied to a benchmark, such as the U.S. Treasury bill rate, the LIBOR or the prime rate.
This means that, unlike conventional bonds, floating-rate bonds may actually appreciate in value during periods of rising interest rates. The flip side? They can also fall significantly in price during declining-rate environments. For a short-term sample of performance, though, PRFRX has a year-to-date gain of 3%, whereas the Barclay’s Aggregate Bond Index is up just 0.4%.
Bottom line: PRFRX can be a smart satellite addition to the fixed-income portion of a diversified portfolio.
As of this writing, Kent Thune did not personally hold a position in any of the aforementioned securities, although he recommends and holds VBMFX for some of his advisory clients. His No. 1 holding is his privately held investment advisory firm. Under no circumstances does this information represent a recommendation to buy or sell securities.
