Short-term yields are now in the 5% range, drawing many fund investors to the front end of the yield curve.
Money-market fund assets recently totaled about $6.5 trillion, continuing their strong growth, according to Crane Data. Nevertheless, it’s a good time to consider funds that hold longer-term bonds as a way to diversify, position for an eventual Federal Reserve rate cut, and even gird against a recession.
In bond parlance, adding longer-dated issues means taking on more duration. Measured in years, duration provides a way to assess a bond’s sensitivity to changes in interest rates. If, for example, a bond’s duration is six years, its price in theory would fall by 6% if rates went up by one percentage point, and vice versa.
Anders Persson, global fixed-income chief investment officer at Nuveen, says the firm has been neutral on duration. Still, he says, “at some point reasonably soon, having more duration in your portfolio makes a lot of sense.”
A key factor is the Fed, which aggressively boosted short-term rates in 2022 and 2023 to tame inflation. That torpedoed the performance of many bond funds, especially those with longer durations.
Heading into this year, the market was expecting the Fed to begin cutting rates multiple times as early as the first quarter. That hasn’t happened yet, owing in large part to lingering concerns about inflation. Whenever it does begin to cut, it could help boost bond performance.
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Timing a Fed pivot is very difficult, however, and “cutting short-term [yields] doesn’t mean long-term yields will fall,” says Paul Olmsted, a fixed-income research analyst at Morningstar. He adds that “a lot of good investors got it wrong last year when they thought that the economy was going into recession.”
Under the recession scenario, the Fed would cut rates multiple times, a potential boon for longer-term bond prices.
Now, investors focused on the front end of the curve face reinvestment risk, warns Gene Tannuzzo, global head of fixed income at Columbia Threadneedle Investments. “If you are sitting in cash or shorter-term bonds, you’d want to be moving out [the curve] in a gradual way, because the Fed is more likely to be moving rates lower than higher,” he says.
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Municipal bonds are worth considering thanks to solid fundamentals, Persson says. And unlike Treasuries, their yields aren’t inverted further out the curve—longer-dated munis still yield more than shorter ones. “You are actually getting paid more to take more risk,” he says.
One option is the actively managed
Vanguard Intermediate-Term Tax-Exempt
fund, which Morningstar describes as “one of the best broad-market active muni options.”
Persson says that another way to get more duration exposure—and to diversify one’s portfolio—is bond funds that invest across different types of securities, such as corporate debt and Treasuries. The “belly of the curve”—bonds with maturities of three to seven years—look attractive.
One option for taking on more duration is the $106 billion
exchange-traded fund, which holds investment-grade securities. Its duration of 6.1 years is about in line with its benchmark. The
iShares Core U.S. Aggregate Bond
ETF, which also offers exposure to investment-grade bonds, has a similar duration.
which is actively managed, also has a duration of about six years. Its holdings include Treasuries and corporate bonds along with mortgage- and asset-backed securities. And there’s
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also actively managed. Its duration is around four years.
For now, at least, duration isn’t the dirty word it was a few years ago.
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