Bond funds made a comeback in the fourth quarter of 2023. Through the end of October, the Morningstar US Core Bond Index, a gauge of the broader fixed-income market, was on pace for a third straight year of losses due to uncertainty around a difficult or weak situation. the landing persisted and interest rate volatility persisted. However, at the end of the year, the bond market rewarded those who stayed the course. The Morningstar US Core Bond Index rose 6.6% in the fourth quarter and 5.3% for the full year.
Credit-sensitive sectors, such as bank loans and high-yield bonds, even generated returns comparable to those of stocks, as they were supported by a relatively healthy and stable economy. In 2023, the average fund in the bank loan and high-yield bond Morningstar categories gained 12.1% each.
On the other hand, investors who accepted more duration risk or sensitivity to fluctuations in returns had a difficult time over the last 12 months. But even long government strategies, which carry significant interest rate risks, made gains in 2023 thanks to a strong finish. Bond yields plunged in the final quarter of the year as market watchers received additional clarity on the trajectory of rate cuts in 2024. As a result, the typical long government fund rose 11.9% over the course of 2024. of the quarter, but gained just 3.0% for the full year as yields soared. during the first nine months.
Here’s a closer look at how some of the biggest bond fund managers fared in another turbulent year and quarter.
High Yield Bonds Soar
High-yield bond managers have struggled with market uncertainty and the threat of recession throughout the year. But as credit markets have remained resilient, managers who reduced their exposure to riskier pockets of the market in anticipation of a recession have lagged behind rivals who either maintained or bet on risky credits. These bonds, as represented by the Bloomberg US High Yield CCC Index, have soared nearly 20% over the year, while the Bloomberg US High Yield BB Index, a gauge of the highest quality segment of the market high yield, increased by 11.6%. High yield credit spreads between rating categories have narrowed over the year.
Artisan High Income ARTFX, whose retail share class has a Morningstar Medalist rating of Silver, was well-positioned to benefit. Known for its concentrated portfolio and high allocation to CCC-rated debt, the retail stocks’ 15.1% rise outpaced the typical 12.1% gain of its high-yield peers. Lord Abbett High Yield’s historically aggressive portfolio, Bronze-rated LAHYX, reduced CCC exposure from 15% to 6% in 2022 and fared worse. Its gain of 10.9% in 2023 is lower than that of almost 80% of its peers.
Longer Duration Strategies End Strong
Funds with shorter durations outperformed those with longer durations during the year. But as yields fell over the past quarter, the intermediate core bond category, comprised of funds with durations typically between 75% and 125% of the Morningstar Core Index’s 6.0-year duration Bond, has generally performed better than its shorter duration counterparts, such as the Ultra Short Bond and Short Term Bond Morningstar Categories. For the quarter, the typical mid-core bond fund gained 6.5%, while ultrashort bond and short-term bond funds rose 1.8% and 3.4%, respectively.
Strategies that suffered the most in the first nine months of 2022 and 2023 due to their longer durations finally saw their fortunes change during the fourth quarter of 2023. For example, Western Asset Core Bond WATFX climbed 8 % during the fourth quarter and broke more than 95%. % of its intermediate core bond rivals, as its duration is longer than that of most of its peers. Its strong performance in the fourth quarter allowed the fund to beat 65% of its competitors in 2023.
One of our favorite picks among core bond managers, Gold-rated Baird Aggregate Bond BAGIX, had another winning year. The fund outperformed its median peer by 82 basis points and beat more than 80% of its competitors. The team’s duration-neutral approach proved effective in a year when returns rose sharply. Consistent outperformance remains the fund’s hallmark.
Tailwinds help emerging market bonds
After a dreadful 2022 and lingering concerns in China, investors who have ventured into emerging market bonds may finally be rejoicing by the end of 2023. The Morningstar Emerging Markets Composite Bond Index gained 9% in 2023, although most of this performance took place in the last quarter, mainly due to falling inflation rates and a weakening dollar.
Some of the leading developing markets managers have seen continued success in 2023. Among those that have stood out are the Bronze-rated T. Rowe Price Emerging Markets Bond PRXIX, the TCW Emerging Markets Income TGEIX, and the Pimco Emerging Markets Bond PEBIX. They all posted returns higher than their peers’ average return of 10.7%. One of the largest funds in the category, Silver-rated MFS Emerging Markets Debt MEDIX, failed to keep pace with its peers and posted below-median returns of 10.4%, mostly in due to the portfolio’s underweighting in certain lower-rated segments of the sector. market which recovered during the year.
Bond funds made a comeback in the fourth quarter of 2023. Through the end of October, the Morningstar US Core Bond Index, a gauge of the broader fixed-income market, was on pace for a third straight year of losses due to uncertainty around a difficult or weak situation. the landing persisted and interest rate volatility persisted. However, at the end of the year, the bond market rewarded those who stayed the course. The Morningstar US Core Bond Index rose 6.6% in the fourth quarter and 5.3% for the full year.
Credit-sensitive sectors, such as bank loans and high-yield bonds, even generated returns comparable to those of stocks, as they were supported by a relatively healthy and stable economy. In 2023, the average fund in the bank loan and high-yield bond Morningstar categories gained 12.1% each.
On the other hand, investors who accepted more duration risk or sensitivity to fluctuations in returns had a difficult time over the last 12 months. But even long government strategies, which carry significant interest rate risks, made gains in 2023 thanks to a strong finish. Bond yields plunged in the final quarter of the year as market watchers received additional clarity on the trajectory of rate cuts in 2024. As a result, the typical long government fund rose 11.9% over the course of 2024. of the quarter, but gained just 3.0% for the full year as yields soared. during the first nine months.
Here’s a closer look at how some of the biggest bond fund managers fared in another turbulent year and quarter.
High Yield Bonds Soar
High-yield bond managers have struggled with market uncertainty and the threat of recession throughout the year. But as credit markets have remained resilient, managers who reduced their exposure to riskier pockets of the market in anticipation of a recession have lagged behind rivals who either maintained or bet on risky credits. These bonds, as represented by the Bloomberg US High Yield CCC Index, have soared nearly 20% over the year, while the Bloomberg US High Yield BB Index, a gauge of the highest quality segment of the market high yield, increased by 11.6%. High yield credit spreads between rating categories have narrowed over the year.
Artisan High Income ARTFX, whose retail share class has a Morningstar Medalist rating of Silver, was well-positioned to benefit. Known for its concentrated portfolio and high allocation to CCC-rated debt, the retail stocks’ 15.1% rise outpaced the typical 12.1% gain of its high-yield peers. Lord Abbett High Yield’s historically aggressive portfolio, Bronze-rated LAHYX, reduced CCC exposure from 15% to 6% in 2022 and fared worse. Its gain of 10.9% in 2023 is lower than that of almost 80% of its peers.
Longer Duration Strategies End Strong
Funds with shorter durations outperformed those with longer durations during the year. But as yields fell over the past quarter, the intermediate core bond category, comprised of funds with durations typically between 75% and 125% of the Morningstar Core Index’s 6.0-year duration Bond, has generally performed better than its shorter duration counterparts, such as the Ultra Short Bond and Short Term Bond Morningstar Categories. For the quarter, the typical mid-core bond fund gained 6.5%, while ultrashort bond and short-term bond funds rose 1.8% and 3.4%, respectively.
Strategies that suffered the most in the first nine months of 2022 and 2023 due to their longer durations finally saw their fortunes change during the fourth quarter of 2023. For example, Western Asset Core Bond WATFX climbed 8 % during the fourth quarter and broke more than 95%. % of its intermediate core bond rivals, as its duration is longer than that of most of its peers. Its strong performance in the fourth quarter allowed the fund to beat 65% of its competitors in 2023.
One of our favorite picks among core bond managers, Gold-rated Baird Aggregate Bond BAGIX, had another winning year. The fund outperformed its median peer by 82 basis points and beat more than 80% of its competitors. The team’s duration-neutral approach proved effective in a year when returns rose sharply. Consistent outperformance remains the fund’s hallmark.
Tailwinds help emerging market bonds
After a dreadful 2022 and lingering concerns in China, investors who have ventured into emerging market bonds may finally be rejoicing by the end of 2023. The Morningstar Emerging Markets Composite Bond Index gained 9% in 2023, although most of this performance took place in the last quarter, mainly due to falling inflation rates and a weakening dollar.
Some of the leading developing markets managers have seen continued success in 2023. Among those that have stood out are the Bronze-rated T. Rowe Price Emerging Markets Bond PRXIX, the TCW Emerging Markets Income TGEIX, and the Pimco Emerging Markets Bond PEBIX. They all posted returns higher than their peers’ average return of 10.7%. One of the largest funds in the category, Silver-rated MFS Emerging Markets Debt MEDIX, failed to keep pace with its peers and posted below-median returns of 10.4%, mostly in due to the portfolio’s underweighting in certain lower-rated segments of the sector. market which recovered during the year.