NEW YORK ( TheStreet ) -- Last year, most bonds faced harsh conditions. According to Morningstar, intermediate-term bond funds lost 1.4% in 2013.
Rising interest rates caused the damage. When rates climb, most bonds tend to sink. The red ink unnerved shareholders, who withdrew $78 billion from intermediate funds.
But some funds stayed in the black. The winners include managers who have the flexibility to buy a wide range of bond sectors and credit qualities, including high-yield bonds, which are considered to be below-investment grade. The low-quality bonds provided an edge last year.
With the economy growing, shaky securities rallied as the risk of default declined. Typical intermediate funds hold few high-yield issues, preferring to emphasize Treasuries and other high-quality securities, which fell last year.
Funds that recorded gains in 2013 include Frost Total Return Bond (FATRX), Nuveen Strategic Income (FCDDX), Pioneer Bond (PIOBX) and USAA Intermediate-Term Bond (USIBX). If rates continue rising this year -- as many economists expect -- the winning funds could continue topping their peers.
Frost Total Return gained 3.8% last year. The fund often moves away from the benchmark sector weightings, focusing on out-of-favor bonds. Portfolio manager Jeffery Elswick has a big stake in commercial mortgage-backed securities. Those represent pools of mortgages made for office buildings and other commercial properties. The commercial mortgages were clobbered during the financial crisis. As property markets recovered last year, the securities revived.
Some of Elswick's holdings returned 10% for the year. "The commercial mortgage-backed securities have been outperforming because the market sold off too much during the financial crisis," Elswick says.
Last year Elswick had up to 15% of his assets in high-yield bonds. As the securities rallied, Elswick started trimming his position. But he says some of the bonds are still appealing. Bonds rated BB -- one step down from investment grade -- yield 5%, an attractive payout at a time when 10-year Treasuries yield 2.7%.