Morningstar - Q2 2021 - 34

Spotlight: Role of Bonds

3
4

2.17

1.44 2
0.08 21
0.04
1.36 0
EXHIBIT 2
EXHIBIT 3
01/02/2008
01/02/2011
01/02/2014
01/02/2017
02/26/2021
0
Yield Compression Core bonds are
Less Income Intermediate core
01/02/2008
01/02/2013 02/28/2021

yielding a fraction of what they
did in 2008.

bond funds are generating low levels
of income for shareholders.

Effective Yield of the Morningstar US Core
Bond Index

Median SEC Yield of Intermediate
Core Bond Funds
6%

6%

4

4

2

2

1.36

1.18
0

01/02/2008

01/02/2013

02/28/2021

0
01/31/2008

01/31/2013

02/28/2021

Source: Morningstar. Data as of 02/28/2021.

Source: Morningstar. Data as of 02/28/2021.

calendar 2020. Even the 30-year Treasury, which
6%
began the period yielding 4.4%, yielded just
over 2% at the end of the period, briefly falling
below 1% in March 2020. No matter what
part of the curve, there isn't much yield to be
4
had in U.S. Treasuries these days.

February 2021 with a figure of merely 1.4%
( E X H I BI T 2 ). This tremendous yield compression
was not only because of the fall in yields
in the U.S. Treasury market but also the result of
similarly compressed yields across agency
mortgages and investment-grade corporate
debt. Both the Morningstar US Mortgage-Backed
Securities Index and the Morningstar US
Corporate Bond Index began the period
with an effective yield of 5.5% and ended the
period with effective yields of 2.1% and
1.3%, respectively.

Treasuries form a major chunk of the U.S.
2
fixed-income market and are often bought in large
1.18
quantities by managers. They also provide
0
an effective floor to the yields of other fixed01/31/2008
01/31/2013 02/28/2021
income instruments, given that they are commonly
taken as the risk-free asset of the global
securities market. All else equal, other fixedincome securities earn a yield premium to equally
dated U.S. Treasuries owing to their higher
risk of default. With Treasury rates as low as they
are, the floor at which yields for other fixedincome securities can sit has also dropped to a
historically low level. Alongside the voracious
appetite for fixed-income securities of all
stripes, this has driven yields in the broad fixedincome market to unprecedented levels.
The yield of the Morningstar US Core Bond
Index, which tracks a broad swath of U.S.
government debt, investment-grade corporate
bonds, and agency mortgages, began
2008 with an effective yield of 4.7% yet ended

34

Morningstar Q2 2021

How Investors Are Affected
There are two widely accepted figures fund
managers use when reporting the income of their
strategies: the trailing 12-month yield and
the SEC yield. The trailing 12-month yield is a
backward-looking figure that shows the
distributions, including interest income, dividends,
and capital gains, paid to investors over the
trailing 12 months from the reporting date. The
SEC yield, a calculation of the net investment
income per share divided by the maximum offering
price per share of a fund over the trailing
30-day period, can be used as an approximate
forward-looking figure for bond funds.
Assuming that each bond in the portfolio is held
to maturity, the SEC yield figure roughly

gives the income a bond fund investor would
receive in a year.
The collapse of yields across the fixed-income
market has meant that core bond fund
managers investing in U.S. Treasuries, agency
mortgages, and corporate credit have
fewer tools at their disposal when seeking to
generate a high level of income. Looking
at the median SEC yield of a group of
distinct intermediate core bond Morningstar
Category strategies vividly illustrates this
fact ( EXHIB IT 3 ).
So, how should owners of core bond funds
navigate this low-yield environment? The
biggest takeaway is a classic maxim of the bond
market: If the fund you're investing in has an
unusually high yield, it's likely taking on potentially
dangerous levels of credit or interest-rate risk.
As my colleague Eric Jacobson noted in the Q4
2020 issue ( " Rising Risk in the High-Quality Bond
Market " ), core bond funds are far more susceptible
to interest-rate shocks because of the steady
lengthening of the duration of the broad fixedincome market. If a core bond fund is posting both
a higher SEC yield and a longer effective duration
than its rivals, this could be evidence of the
strategy opening itself up to a higher drawdown
should rates spike unexpectedly in the near future.
While the broad U.S. Treasury, agency mortgage,
and investment-grade corporate credit
indexes have seen their effective yields compress
to extremely tight levels in recent months,
the corporate bond market has largely offered a
yield premium to securitized and government fare
over the past decade. Many core bond fund
managers, therefore, have flocked to this market
to gain more yield than their rivals.
From January 2008 through February 2021, the
percentage of assets in corporate bonds held
by the typical intermediate core bond strategy rose
to just under 30% from 20%. This trend is not
just because of managers seeking a yield premium
from corporate bonds-it is also conceivable,
given the growth of corporate bonds as a
percentage of indexes like the Morningstar US
Core Bond Index (where corporate bond exposure



Morningstar - Q2 2021

Table of Contents for the Digital Edition of Morningstar - Q2 2021

Contents
Morningstar - Q2 2021 - Cover1
Morningstar - Q2 2021 - Cover2
Morningstar - Q2 2021 - 1
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Morningstar - Q2 2021 - Cover3
Morningstar - Q2 2021 - Cover4
Morningstar - Q2 2021 - M1
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