3 Bond Funds That Could Benefit from a Fall in Long-Term Yields

After raising short-term interest rates since March 2022, the Federal Reserve has started easing monetary policy with a 50-basis-point rate cut in September 2024 and a 25-basis-point rate cut on Nov. 7. The federal-funds rate, which is the interest rate at which banks lend money to each other overnight, is now targeted between 4.50% and 4.75%.

The Fed raises or lowers the federal-funds rate to help manage economic growth and the rate of inflation, which is the largest driver of long-term yields. Changes in bond yields can affect bond prices to differing degrees; duration helps provide an estimate of how much. In simple terms, a bond’s duration can help investors estimate how much a bond’s—or portfolio of bonds—price will be affected by a change in long-term yields. Bond funds with longer durations are more sensitive to changes in bond yields.

Bond prices and yields have an inverse relationship—as yields fall, bond prices rise. For example, the price of a high-quality bond with a 5.0-year duration will rise/fall by approximately 5% with a 1-percentage-point drop/rise in the underlying like-duration yields. Putting those concepts together explains why longer-duration bond funds will typically gain more than shorter-term bonds if yields fall across the maturity spectrum.

Here are three intermediate core-plus bond funds that have maintained above-average durations and stand to benefit more than their peers if yields fall.

TCW MetWest Total Return Bond’s MWTRX investment process touts a sensible balance between flexibility and discipline. This fund, which has a Morningstar Medalist Rating of Silver, is benchmarked against the Bloomberg US Aggregate Bond Index, but its managers actively adjust duration relative to the index and have the flexibility to invest outside the benchmark. The team’s approach to duration management leads it to increase duration as rates rise, and this has hurt its returns in recent years. The fund’s roughly 6.9-year duration on average over the past two years through September 2024 was about eight tenths of a year longer than the durations of its typical peer and benchmark. While this weighed on its trailing three-year returns through October 2024, if yields fall and the fund maintains its posture, it should outperform.

Next up is Gold-rated Loomis Sayles Core Plus Bond NERYX. The expertise of the four veteran named managers and a focus on value and balancing risk set this strategy apart. The managers here start with a top-down approach to determine sector weightings, yield curve, and duration positioning. While the strategy keeps duration within 2.0 years of its benchmark, the managers increased Treasuries exposure at a time when yields were rising and Treasuries were becoming more attractive compared with riskier assets; that also had the intended effect of lengthening the portfolio’s duration. The strategy’s duration hit a high of 7.5 years in August 2023 and shortened to 6.8 years as of September 2024. However, its duration remains longer than the peer median of 6.1 years.

Silver-rated Hartford Total Return Bond’s ITBFX well-structured yet flexible approach tracks the Aggregate Index, but it can travel much further afield. It incorporates a mix of investment-grade corporates, Treasuries, and agency mortgages but also includes out-of-benchmark stakes in riskier securitized credit, foreign bonds, and currencies. That said, the team has been mindful of increasing exposure to lower-quality credits only when it finds value. The strategy can also deviate from the duration of its benchmark, although the managers tend to maintain it within a third of a year of its index’s. The strategy entered 2023 with a longer duration of 6.9 years than its peer median’s 6.1 years in anticipation of an end to the Fed’s hiking cycle. After reaching a high of 7.1 years in June 2024, the strategy’s duration was down to 6.7 years as of September 2024. Still, the duration is longer than its typical peers, making this strategy poised to reap the benefits of falling long-term yields.

A version of this article first appeared in the October 2024 issue of Morningstar FundInvestor. Download a complimentary copy of FundInvestor by visiting this website.