Investors in the most widely held bond funds posted widespread losses in the second quarter as stubbornly high inflation and rising interest rates weighed on returns.
At the end of the quarter, concerns about the strength of the economy began to hurt more credit-sensitive strategies as fears of recession raised concerns about the possibility of higher default rates on corporate debt .
But the driving force between bond market returns has been continued inflation at higher than expected levels towards the middle of the year. As the consumer price index posted its biggest increases in more than four decades, the Federal Reserve accelerated its interest rate hikes. That led to a three-quarters percentage point hike in the federal funds rate in June, the first tightening of this magnitude since 1994.
For bond investors, that meant a second straight quarter of losses across the vast majority of funds, including those most widely held by investors. And in the middle of the year, bond fund investors face some of the worst losses in market history.
The largest bond strategy, Vanguard Total Bond Market Index (VBMFX), which holds $317 billion, lost 4.74% in the quarter. The fund, which holds high-quality, fixed-rate, taxable US bonds, lost 10.4% through the end of June. Prior to this year, the worst calendar loss for the 35-year-old fund was 2.7%, recorded in the bond market bear of 1994.
During the quarter, funds that invest in bonds globally also posted sharp declines as central banks raised rates. The Vanguard Total International Bond Index Fund (VTIFX) fell 5.15%.
However, it was funds with higher levels of credit risk that fell further. The iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD)with $31.4 billion in assets, fell 8.6% in the second quarter.
Funds focused on shorter-term bonds, less sensitive to changes in interest rates, held up better. The Vanguard Short Term Bond Index (VBISX) was down 1.2% in the second quarter.
Here’s a look at the results of the 10 largest passively managed US bond funds and the 10 largest actively managed US bond funds, according to Morningstar Direct. A table with the long-term results for the 20 funds can be found at the end of this article.
Second-quarter performance of the largest passively managed bond funds
The iShares Core US Aggregate Bond ETF tracked the overall decline in bond prices during the second quarter. (AGG), which lost 4.7%. The gold-rated exchange-traded fund mirrors the widely tracked Bloomberg US Aggregate Bond Index, which includes high-quality taxable bonds denominated in US dollars.
“The relative performance of the fund category will largely depend on the performance of credit risk bonds,” writes Bryan Armour, director of passive strategies research at Morningstar, North America. “It should hold up well during times when credit markets are stressed, but it will lag when they recover. As it takes on little credit risk, the main driver of the fund’s absolute performance will be interest rate.
Among the largest bond index funds, Vanguard Short-Term Bond Index (VBISX) posted the best returns compared to its peers in the category. The fund’s conservative approach “is significantly less sensitive to credit risk compared to the category average,” notes the latest report on the fund.
The iShares iBoxx $ Investment Grade Corporate Bond ETF had the worst performance at the category level, falling 8.6%. Through the end of June, the fund was down 16.1% in 2022. The fund tracks the Markit iBoxx USD Liquid Investment Grade Index, which includes high-quality US corporate bonds with at least three years up to at the due date. “The bond fund’s omission of less than three years to maturity creates greater exposure to interest rate risk than most of its peers in the category,” the latest analyst report says. of the fund.
Even inflation-protected bond funds could not avoid the downward trend in the bond market. Although funds that hold US Treasury inflation-protected securities provide a hedge against rising inflation, they are not immune to the negative effect of rising rates. Compared to its peers in the category, the iShares TIPS Bond ETF is more interest rate sensitive. At the end of June, the fund’s 9% loss put it in the 62nd percentile of the inflation-protected bond category.
Second-quarter performance of the largest actively managed bond funds
Among actively managed bond funds, Lord Abbett Short Duration Income (LALDX) held up better. The fund lost 1.8%, putting it in the 50th percentile of the short-term bond category.
Vanguard Short Term Investment-Grade (VFSTX) was down 1.9%. Morningstar associate director Elizabeth Foos writes that the fund has “a well-structured process and benefits from ultra-low fees, making it a strong candidate for short-term bond exposure.”
Dodge & Cox Income (DODIX) among the largest core-plus intermediary bond funds. It lost 4.7% in the quarter, compared to an average loss of 5.7% in the category. Senior analyst Sam Kulahan says the fund outperformed mainly due to its short duration, which means it is less sensitive to changes in interest rates.
“As of March 2022, its duration was 1.3 years shorter than the median for the core-plus category,” Kulahan says. “In March 2022, it also held healthy allocations to agency mortgages, asset-backed securities and short-term Treasuries, all of which outperformed in the quarter against investment-grade and high-end companies. performance and longer term rates.
PGIM Total Return Bond (PDBAX) among the largest bond funds relative to its category. It fell 6.8% to the 89th percentile in the core-plus mid-bond category. In March, Morningstar strategist Eric Jacobson wrote that “the supply has felt the heat lately, but it’s a cool long-term customer.” The fund’s “above-average volatility is not unexpected and is kept under control by a strong risk management framework.”
In the multi-sector bond category, Pimco Income (PIMIX) held up well. The fund fell 5.2%, putting it in the 32nd percentile. Jacobson notes that the fund “endured difficulties at the start of 2022, having raised a combination of 2% to 3% bond and currency exposures to Russia at the start of the year”.
“Nevertheless, the strategy outperformed many multi-sector bond peers in the Morningstar category on rising global bond yields entering the year with a duration of 1.15 years, largely due to exposure 5.5% to inflation-linked bonds,” he writes.