3 Best Bond Funds to Own Now

With increasing volatility in stock prices and a hike in interest rates looking more likely to be pushed into 2016, bond funds are suddenly more attractive than they were at the beginning of 2015.

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Looking over the past two or three years of failed predictions on the end of quantitative easing and the beginning of rate hikes, jumping out of bonds and bond funds has been a largely unwise move.

In fact, the most interest-rate-sensitive bond funds outperformed stocks in 2014, when many prognosticators expected interest rates to begin rising (and thus bond prices to fall). For example, Pimco 25+ Year Zero Coupon US Treasury (ZROZ) jumped 48.8% in price last year. This compares to a broad market U.S. stock index fund, such as the SPDR S&P 500 ETF (SPY), that had a 13.5% gain.

In 2015, however, interest-rate-sensitive bond funds are not looking like a good bet, to say the least. ZROZ has dropped 13% in price year-to-date, which compares to a milder 1.5% decline on the Barclays Aggregate Bond Index (AGG).

So what are the best bond funds to buy now? Here are three of the best to consider:

Best Bond Funds to Buy Now: Vanguard Intermediate-Term Bond Index (VBIIX)

Best bond funds, VanguardExpenses: 0.2%
Minimum Initial Investment: $3,000

Conventional wisdom says not to buy passively managed bond funds in rising-interest-rate environments, but Vanguard Intermediate-Term Bond Index (VBIIX) is a smart choice now.

A big part of what knocked Bill Gross off his bond king throne was his failure to see a prolonged low-rate policy on the part of the Federal Reserve Board. For the same reason, actively managed funds have declined in popularity, and index funds — especially those at Vanguard — have taken the crown of leadership, at least in assets.

But will conventional wisdom prevail in 2015? Will the tide turn back to actively managed funds? Look no further than YTD performance as a clue. The YTD return for VBIIX is 0.3%, which is ahead of the Barclays Aggregate Bond Index (actually down -3%) and beats nearly 80% of all intermediate-term bond funds.

Best Bond Funds to Buy Now: T. Rowe Price Floating Rate (PRFRX)

Best bond funds, T. Rowe PriceExpenses: 0.85%*
Minimum Initial Investment: $2,500

If you’re looking for a bond fund that can perform reasonably well amid rising interest rates, T. Rowe Price Floating Rate Fund (PRFRX) may be the best no-load offering available.

Also called bank loans, floating-rate notes or “floaters,” these 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.

On the one hand, unlike conventional bonds, floating-rate bonds may actually appreciate during periods of rising interest rates. On the other hand, they can also fall significantly in price during declining-rate environments.

Thus far, in 2015, PRFRX looks good. Its YTD gain of 3.4% leads more than 90% of other bank loan bond funds and it smashes most conventional bond funds, which are fortunate to be above zero on the year.

* A fee waiver expires on Sept. 30, 2015, that limits expenses to 0.85%. Current gross expense ratio is 0.86%.

Best Bond Funds to Buy Now: Vanguard Short-Term Bond Index (VBISX)

VanguardExpenses: 0.2%
Minimum Initial Investment: $3,000

Vanguard gets another nod in our gallery of best bond funds to buy now with Vanguard Short-Term Bond Index (VBISX).

Bond prices move in the opposite direction as interest rates and shorter maturities are less sensitive to rising interest rates than longer maturities. Therefore, a solid short-term bond fund can be a smart choice now.

Having low expenses also helps give a performance edge to bond funds, especially those in the short-term category.

Thus far in 2015, VBISX is proving its worth as a high-quality, low-cost short-term bond fund. The YTD return of nearly 1% beats the Barclays Aggregate Bond Index, which is below 0% on the year, and it beats 75% of short-term bond funds.

As the market inches closer to its first rate hike, due later this year or early 2016, Vanguard Short-Term Bond Index may continue to be a smart fixed income choice.

As of this writing, Kent Thune did not personally hold a position in any of the aforementioned securities. His No. 1 holding is his privately held investment advisory firm in Hilton Head Island, SC. Under no circumstances does this information represent a recommendation to buy or sell securities.

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