Investors willing to stretch the duration of their bond portfolio a bit further might consider the Vanguard Short-term Corporate Bond Index Fund. Both the E.T.F. and mutual fund versions of the fund have yielded around 1.7 percent over the last 12 months and have an average duration of three years.
For those already willing to take the risk of holding high-yield bonds — also known as junk bonds because of their relatively low credit quality — Kathy Jones, the chief fixed income strategist at the Schwab Center for Financial Research, suggested shifting some of those holdings to bank loan funds. As the name implies, such funds invest in loans made by banks and other financial institutions to corporations. They tend to have a shorter portfolio duration — often measured in just a few months — than high-yield bond funds. But in a downturn, they can be risky.
So, for example, during panic selling from Feb. 20 to March 23, 2020, early in the pandemic, the S&P 500 plummeted 34 percent, and bank loan funds and high-yield bond funds both fell on average 20 percent, according to Morningstar Direct. By comparison, short-term bond funds lost, on average, less than 5 percent of their value.
Bank loan funds have fared better as investors hunted for yield over the past year. The T. Rowe Price Floating Rate Fund had a total return of 7.16 percent for the 12 months ending on Sept. 30 and a trailing 12-month yield of 3.93 percent, according to Morningstar Direct. The managers of that fund typically put 80 to 90 percent of the portfolio into bank loans. The fund’s expense ratio is 0.76 percent.
Although shortening the duration of a bond portfolio might mitigate the shocks of interest rate increases, it doesn’t directly address the problem of persistent inflation.
“I would not be a good bond manager if I did not say that inflation is a concern,” said Adrian Helfert, the chief investment officer of multi-asset strategies at Westwood Management, an investment management company based in Dallas. “It does erode the future value of an investor’s portfolio.”
A well-worn anti-inflationary tool in the bond investor’s kit is Treasury Inflation Protected Securities, better known as TIPS. The principal of these government-issued securities adjusts with inflation.