NEW YORK (FMD Capital Management) -- Bond funds were largely written off in 2013 as tens of billions poured out of these stalwart dividend vehicles last year. Fears over rising interest rates helped to put downward pressure on fixed-income and aggregate bond indexes realized their worst year in nearly a decade. Speculation over the Federal Reserve tapering its quantitative easing efforts only added fuel to the inflationary debate as well.
However, the combination of weakening economic data and stock market volatility has led to resurgence in bonds this year that should be a wake-up call for income investors. The realization that tapering has not led to a significant rise in interest rates should be another red flag that bonds aren't as dangerous as they have been made to seem.
Many performance chasing portfolios are now overweight stocks and underweight bonds which could spell disaster if the market continues to show signs of weakening. The following five funds represent actively managed fixed-income strategies that offer the opportunity for capital appreciation and solid dividend streams this year.
PIimco Income Fund
Despite the looming threat of higher interest rates, I am still continuing to look for opportunities in fixed-income that are designed to maximize income while focusing on risk management. An actively managed mutual fund that is one of my favorite core holdings is the PIMCO Income Fund (PONDX), which is managed by Dan Ivascyn.
Coincidentally, Ivascyn was just recently named the 2013 Bond Fund manager of the year by Morningstar and was promoted to deputy CIO at Pimco. He has a long track record of spotting early trends and capitalizing on security selection through this research.
PONDX takes a multi-sector approach to specific areas of the bond market that the manager feels will outperform over time. They have done a fantastic job of managing interest rate risk in 2013 and taking advantage of opportunities (both inside and outside the U.S.) when they are available. This has led to 2013 returns of better than 4.5%, an effective duration of less than 5 years, and a current 30-day SEC yield of nearly 4%.
One of the interesting features of PONDX is that the fund accrues interest daily and distributes it monthly. So it does not subtract dividends from the NAV of the fund when distributions are paid. This allows you to reinvest additional shares as income that builds your position over time.
Loomis Sayles Bond Fund
Another multi-sector bond fund that takes a different approach to diversification is the Loomis Sayles Bond Fund (LSBRX). This fund seeks high total investment return through a combination of current income and capital appreciation. One of the interesting characteristics of LSBRX is that it may invest up to 20% of its assets in common or preferred stocks and up to 20% in international develop or emerging market countries.
The manager believes that this non-traditional diversification strategy will enhance the long-term returns of the portfolio vs. its benchmark. A fund like LSBRX is hard to categorize because it has the ability to hold such a wide array of investment options in its arsenal. However, the historical results have impressive. It had a 2013 total return of 5.52%, 3-year annualized return of 7.81%, and five-year annualized return of 14.20% according to the fund manager's website.
The fund is currently managing nearly $22 billion in total assets with a 30-day SEC yield of 3.27%. If you are looking for a global strategy that offers a unique asset allocation slant, then LSBRX should definitely be on your radar.
DoubleLine Total Return Fund
When it comes to maximizing total return, one of the best bond fund managers in the world is Jeffrey Gundlach who leads the Doubleline Total Return Fund (DLTNX). This fund manages over $30 billion in total assets primarily in mortgage backed securities of varying credit qualities and durations. This fund currently has an average duration of just 4.11 years, a 30-day SEC yield of over 5%, and an expense ratio of 0.78%.
I like DLTNX because of the manager's expertise in research, security selection and active risk management strategies. Gundlach is known for shifting his portfolio to adjust to the interest rate and credit climates when they sense volatility on the horizon. The fund was essentially flat in 2013, but is already surged back near its all-time highs to begin 2014.
According to a recent fact sheet, since the fund was introduced on April 6, 2010, it has produced annualized returns of 9.04% through December 31, 2013. In comparison the Barclays U.S. Aggregate Index has produced returns of just 4.03% over the same time frame.
Osterweis Strategic Income Fund
Managed by the boutique investment management firm Osterweis Capital Management, the Osterweis Strategic Income Fund's (OSTIX) strategy seeks to provide capital preservation in concert with long-term total return. The fund currently has $6 billion in assets under management as of the end of January.
The fund typically invests in short-duration high-yield bonds, as well as convertible bonds, to achieve its objectives. However, the strategy carries the flexibility to allocate anywhere in the fixed-income universe. This type of flexibility presents a great value proposition since it isn't forced to hold longer-duration Treasury and agency MBS holdings that make up the Barclays U.S. Aggregate Index.
It is a "risk-aware" strategy, meaning it will adapt to changes in interest rates, or move to cash in an attempt to shield its investors from an unfavorable investment outcome. This is precisely what OSTIX did for investors in 2013 with a total return of 6.58% and very low overall volatility. It should be noted that this strategy pays quarterly dividends and has a current 30-day SEC yield of 3.04%.
Metropolitan West Low Duration Fund
If the threat of rising interest rates still has you nervous or you are just looking for some additional return on excess cash lying around, you may want to consider the Metropolitan West Low Duration Bond Fund (MWLDX). The objective of this fund is to maximize current income consistent with capital preservation.
MWLDX has a reasonable expense ratio of 0.57% and pays a current 30-day SEC yield of 1.10%. The portfolio is made up primarily of investment grade securities in mortgage, corporate, and government bonds. The average duration of the portfolio is just 1.21 years which means that you are getting a mix of bonds that are going to be less sensitive to swings in interest rates.
While you sacrifice some yield and capital appreciation potential, at least you know that a slice of your portfolio is generating income without taking too much risk. In 2013, MWLDX had a total return of 1.93% and is rated 4-stars by Morningstar.
The Bottom Line
In my opinion, fixed-income is one area of the market where a talented manager can have a significant impact on performance above and beyond their benchmark. While many people have written off bonds entirely, I view them as an opportunity for strategic positioning and lowering portfolio volatility.
Even in the face of rising interest rates, there are still specific areas that will outperform which is why having a watch list of core holdings is essential.
At the time of publication the author had a position in PONDX, DLTNX and OSTIX.
This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.