NEW YORK (TheStreet) -- Most bond ETFs have sunk lately. This year Vanguard Total Bond Market (BND) has dropped 4.6%, while iShares Barclays 20+ year Treasury Bond (TLT) fell 12.5%, according to Morningstar. Rising interest rates have caused the damage. When rates rise, bond prices tend to fall as investors dump existing issues with low yields.AGG), which tracks the Barclays Aggregate, lost 2.0%. In comparison the yield on 10-year Treasuries climbed 100 basis points during the six months ending in March 2011. But because the duration was shorter then, the ETF only lost 1.4%. BSV), which has a duration of 2.72 years and lost only 0.5% in May. Another approach is to buy actively managed mutual funds that can shorten their durations when rates rise. Mutual funds that outdid the benchmarks during the recent downturn include Ave Maria Bond ( AVEFX), Frost Total Return Bond ( FATRX), Scout Core Plus Bond ( SCPYX) and Western Asset Mortgage Backed Securities ( SGVAX).
The Western Asset fund ranks as one of the stars of the recent downturn. While most bonds lost money in May, Western Asset gained 1.2% for the month. The fund holds securities that are backed by pools of mortgages, which often yield more than Treasuries and tend to be resilient in downturns. "The mortgage market is one of the few fixed-income sectors where you can get some shelter from higher rates," says portfolio manager Steve Fulton. While most mortgage securities cannot default because they are backed by government agencies, Western Asset has about a quarter of its assets in non-agency mortgages. Those did not qualify for government backing because the loans were too large or homeowners had weak credit records. While the non-agency mortgages can default, they compensate with richer yields. In May, non-agency securities performed particularly well. With the economy improving, investors figured that the risk of default was lower and bid up prices of shakier mortgages. Follow @StanLuxenberg This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.