Even the casual observer of bond funds knows that 2018 has so far been tough on the wallet. On several occasions, the yield on the bellwether 10-year Treasury has briefly breached 3%.

However, the yield curve has been flattening because the Fed has been busy raising short-term interest rates. It’s already done so twice this year with two more hikes expected.

That would mean the Fed will have raised rates nine times since December 2015 to a top range of 2.25% to 2.50%. Against that backdrop, taxable and muni funds have struggled. Here’s how we’re playing today’s interest-rate environment.

While rising short-term interest rates obviously weigh on the value of existing short-term notes, bond funds hold securities of varying maturities. So, as older maturing bonds effectively “age out” of a fund, they’re replaced by new, higher-yielding bonds.

This is true in shorter-term bond funds, and it’s especially true in the super-short duration Fidelity Conservative Income Bond (FCONX) whose holdings are constantly replaced. Albeit ever-so slightly, this portfolio churning is what’s actually helping to keep this year’s performance (up 1.1%) in the black.

With its weighted average maturity well short of a year, Conservative Income is a kind of money market fund on steroids. Yes, it’s riskier than holding a “cash” fund because it takes more credit-risk than money funds are allowed to assume.

Notably, non-prime money markets hold very, very short-term government paper, whereas Fidelity Conservative Income is 90% invested in riskier corporate bonds, including a sizeable chunk (about a third) in foreign corporate bank loans. (The fund’s overall credit quality is “medium.”)

As to an earlier point, duration is a short 0.13 years, suggesting that a 1% rise in interest rates would clip 0.13% of the fund’s value. Viewed another way, about half the fund’s assets mature inside 30 days. That leaves Managers Rob Galusza and Julian Potenza with the opportunity to constantly replenish the fund with slightly higher-yielding bonds.

Print Friendly, PDF & Email