How Have Bond Funds Done This Year?

 | Sep 08, 2017 | 7:00 AM EDT
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Stock quotes in this article:

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As the newest high-yield bond fund, Goldman Sachs Access High Yield Corporate Bond ETF (GHYB) launched to some fanfare Thursday. It's a good time to check on the performance of bonds (and bond funds) this year. Stocks get the lion's share of the financial media's attention, but bond funds can provide diversification, and almost all provide better yields than the S&P 500's puny 1.92%. I haven't had time to analyze Goldman's new ETF yet, but if the question is, "How have bond funds done in 2017?" the simple answer is they have performed well ... and certainly outperformed Goldman's lagging stock (GS)

The ETF database I use lists 322 separate fixed-income ETFs and iShares alone offers 84, but for the sake of clarity, I'll use a few of the iShares flagship ETFs to represent fixed-income subcategories. The most basic iShares fund, iShares Core U.S. Aggregate Bond ETF (AGG) , has posted a 3.79% total return thus far in 2017 based on Morningstar's performance data. For those willing to stomach more risk, the benchmark iShares iBoxx $ High Yield Corporate Bond ETF (HYG) has returned 5.27% thus far in 2017. Bonds from emerging markets have been one of the hot categories this year, and have generated a lot of chatter among my friends who work at hedge funds. The performance has lived up to the hype, as iShares Emerging Markets High Yield Bond ETF (EMHY) has posted an 8.65% return thus far this year. 

While "emerging market" and "high yield" are two phrases that invariably scare off risk-averse investors, it is interesting to note that there is an iShares ETF that has outperformed even the red-hot EMHY this year. Unlike its exotic bond fund cousins, analyzing this one doesn't involve trying to discern the cash flows of sub-Saharan companies or working out the debt surpluses of countries that have smaller GDPs than Apple has cash on the balance sheet. 

No, the best performer among the benchmark bond ETFs has been right in front of our noses the whole time. IShares 20+ Year Treasury Bond ETF (TLT) has posted a 9.23% return year to date. Yes, this is the same TLT that is widely loathed by those same hedge-fund types due to its exposure to fixed coupons over long periods of time (i.e., duration risk) and the feckless nature of the U.S. federal government. I can't tell you how many times I've been at a gathering of hedgies and heard someone opine, "Short TLT is my favorite play." Well, the people opining that have been wrong for years, and especially in 2017. 

So how is it that a fund that only invests in long U.S. Treasuries can perform so well ... or why is there so much demand for long-term U.S. government paper when the yield on the 10-year is currently 2.04%? Well, of course, the yield on the 10-year is a factor of the price (not the other way around), so it is demand for risk-free assets that has driven the bond rally, not the coupons on the bonds themselves. It's the kind of trade that causes academics and hedgies to scream "bubble," but a look at the St. Louis Fed's chart of the 10-year Treasury shows that the current downturn in yields began in September 1981. 

Yes, that's 36 years ago, and while one might have made a few shekels on short-term bets against the 10-year during that time period, the long-term trend is clear. 

So I'm not willing to call an end to this megatrend, and I'm still holding bonds. My firm's bond holdings are all corporates -- we do not hold Treasuries -- but even as hedge-fund types look at TLT's performance and continue uttering "WTF?" to themselves, I know benchmark risk is a real factor in bond investing. Or it was 36 years ago. Without any benchmark risk to speak of, corporate bonds are much easier to value, and their higher coupon rates produce wonderful returns over time thanks to the magic of compounding. 

So I'm sticking with bonds, and I'll have more details on which ones I am buying in an upcoming column.

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