5 Taxable Bond Funds to Invest in Despite Record Outflows

Taxable bond funds are debt securities whose interest payments are taxable at the local, state or federal level. Concerns about higher interest rates resulted in a massive sell-off in taxable bond funds in the third quarter of this year. Federal Reserve Chairwoman Janet Yellen indicated that the lift-off option is very much on the table later this year provided the economy is strong enough to boost employment and inflation touches the desired level.

Moreover, worries about global growth, mostly in emerging economies, led to the outflow in taxable bond funds. Nevertheless, these type of funds showcased strength in an otherwise punishing market environment. They posted steady returns amid the stock market sell-off. They are even poised to yield better results banking on stepped-up economic activity, rising business and consumer confidence, improving housing market and continued job creation. Hence, investing in these funds should be a prudent idea.

Taxable Bond Funds Suffer Huge Outflows

Investors have pulled $36.2 billion out of taxable bond mutual funds in the third quarter of this year, according to the preliminary Lipper data. This represents the biggest outflow from this fund type since the fourth quarter of 2008.

In fact, taxable bond mutual funds continued to bleed in the week ended Oct 7. During the week, investors pulled $2.3 billion out of taxable bond mutual funds, registering its 11th continuous week of net withdrawals. This dismal performance came in after taxable bond mutual funds posted their second largest weekly outflow on record for the week ending Sep 30.

In the first half of the year, however, taxable bond mutual funds had posted an inflow of more than $23 billion. But if this current outflow continues for the rest of the year, taxable bond mutual funds will mark their first annual net outflow since 2000.

According to Jeff Tjornehoj, head of Americas research at Lipper, outflow from this type of funds was broad based as it was spread across all types of categories and companies. He added: "Investors are getting out of these bond funds because of fear. An unfounded fear, in my opinion, of higher rates and a global recession."

Higher Rates, Global Growth Concerns

Concerns about higher interest rates in the near term resulted in outflows from taxable bond mutual funds. Last month, the Fed Chairwoman Janet Yellen said that the Federal Open Market Committee (FOMC) members "expect that the various headwinds to economic growth ... will continue to fade, thereby boosting the economy’s underlying strength."

She added: "Most FOMC participants, including myself, currently anticipate that achieving these conditions will likely entail an initial increase in the federal funds rate later this year, followed by a gradual pace of tightening thereafter."

Worries about global economic growth, especially in the emerging economies including China, also led to outflow from bond funds. Markets across the world took a beating in response to the slowdown in China’s economic growth and its surprise move to devalue its currency. Weak Chinese trade data also raised concerns about the country’s growth outlook. While its exports were down 3.7% in September from the same period last year, its imports plunged 20.4% last month from a year earlier.

Separately, other emerging markets also face the threat of instability, since their debts are vulnerable to rising interest rates in the US. Overall, the International Monetary Fund downgraded its global growth forecast for this year to 3.1%, which will result in the weakest growth performance since 2009.

5 Taxable Bond Funds to Buy as it Shows Signs of Stability

Despite the outflows this year, taxable bond mutual funds are holding up a lot better than the stock markets. Amid volatility in the financial markets, returns from this type of funds remain more or less stable for the year, while the S&P 500 is down 2.7% year to date. Additionally, taxable bond mutual funds have given a steadier average annual return of 4.3% in the last 10 years.

Moreover, flows are a result of economic events. A gradual recovery in domestic housing and manufacturing sectors, steady improvement in labor market conditions and lower gasoline prices are expected to boost the US economy in the near term. These factors are likely to have a positive impact on the fund’s performance.

Several taxable bond mutual funds are excelling this year. Below we present five such bonds that have given steady returns, possess a relatively low expense ratio and boasts a Zacks Mutual Fund Rank #1 (Strong Buy) or Zacks Mutual Fund Rank #2 (Buy).

Buffalo High-Yield (BUFHX) invests a major portion of its net assets in higher yielding, higher-risk fixed income securities.BUFHX currently carries a Zacks Mutual Fund Rank #1. BUFHX’s year-to-date and 1-year total returns are 3.2% and 4.7%, respectively. Annual expense ratio of 1.02% is lower than the category average of 1.06%.

Vanguard Intermediate-Term Investment-Grade Investor (VFICX) invests in a widely diversified group of intermediate-term bonds, most of them issued by corporations with good credit ratings. VFICX currently carries a Zacks Mutual Fund Rank #2. VFICX’s year-to-date and 1-year total returns are 2.1% and 2.2%, respectively. Annual expense ratio of 0.20% is lower than the category average of 0.84%.

Columbia Strategic Income Fund Class A (COSIX) invests in debt securities issued by the US government, including mortgage-backed securities issued by US government agencies. COSIX currently carries a Zacks Mutual Fund Rank #1. COSIX’s year-to-date and 1-year total returns are 1.2% and 1%, respectively. Annual expense ratio of 1.04% is lower than the category average of 1.27%.

SEI Daily Income Trust GNMA Fund Class A (SEGMX) invests primarily in mortgage-backed securities issued by GNMA. SEGMX currently carries a Zacks Mutual Fund Rank #1. SEGMX’s year-to-date and 1-year total returns are 1.1% and 2.2%, respectively. Annual expense ratio of 0.63% is lower than the category average of 0.91%.

Performance Trust Strategic Bond (PTIAX) invests a major portion of its net assets in fixed-income instruments. PTIAX may also invest in derivative instruments.PTIAX currently carries a Zacks Mutual Fund Rank #1. PTIAX’s year-to-date and 1-year total returns are 2.3% and 3.1%, respectively. Its annual expense ratio of 0.94% is lower than the category average of 1.03%.

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