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Nicholas Wanstall Group

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Daniel Lazarev
Daniel Lazarev

Best Bond Funds To Buy

Yields on high-grade corporate bonds appear compelling. However, from a credit-spread perspective, we see too little compensation above risk-free Treasuries given the late-cycle risks in the market.Spreads do have room to widen, but a renewed investor appetite for higher-quality bonds may put a ceiling on how wide spreads could drift.

best bond funds to buy

We expect tighter financial conditions to crimp corporate finances broadly. Rising stars (company upgrades from high yield to investment grade) outpaced fallen angels (downgrades from investment grade) by a wide margin over the past two years. Still, we expect more downgrades in 2023, especially in lower-quality cyclical segments. The depth and duration of any market downturn would determine the impact, but we see that most companies are prepared for a normal recession.Within a more modest allocation to investment grade, we see value in higher-quality issues within financials, utilities, and noncyclical industries. We prefer noncyclical companies because they tend to retain earnings resilience during economic downturns. Though bonds of cyclical companies can have higher spreads at challenging times, they currently trade in line with noncyclicals, another reason we see noncyclicals as the better bet.

Some stabilization in U.S. Treasury rates could be a catalyst for emerging markets (EM) inflows. We saw that occur over the last few months of 2022 during a period of light EM bond issuance, and historical data suggest an improving trend. That should bolster the supply/demand picture for EM, as we see another year of net negative supply.Our more favorable view on the sector late last year benefited from the 125 bps rally in spreads, but it leaves us less constructive today with valuations no longer cheap.Country fundamentals are broadly stable, but we anticipate significant credit differentiation as the global economy slows down in 2023. This will create opportunities for relative value and active management.Our preference for higher-quality bonds is balanced by the fact that spreads in investment-grade EM are very tight and additional borrowing is likely. The high-yield segment of EM offers much more compelling valuations but is also the most vulnerable to further economic disruption.We see 2023 as a market where the best strategy is to be defensive but agile, with enough liquidity to act on new opportunities that arise.

With the Fed making significant progress in hiking interest rates, headwinds should moderate in 2023. Following a year with $119 billion of outflows from municipal funds and ETFs, we expect the tide to turn.

After all, if individual investors and advisors had allocations to municipals with yields barely over 1% at the beginning of 2022, then they should now salivate at the prospect of yields exceeding 3% (before adjusting for tax benefits). With tax-loss harvesting opportunities ending, we expect that high-earning investors will be motivated to increase their tax-exempt holdings over time. Higher yields not only mean greater income but also greater portfolio stability if a deeper recession transpires.The tax-exempt primary bond market was busy at the start of 2022, but higher rates stunted the pace of issuance later on, consistent with our forecast. The supply picture going forward is uncertain, as usual, yet future issuance will likely remain subdued as the cost of borrowing is higher and municipal balance sheets are still flush with cash from pandemic-era stimulus.Both inflows and lower supply should support municipal valuations in 2023. The quick 4.1% rally in the fourth quarter indicated that these effects are underway. The rebound may lure more investors back with attractive yields and reduce the possibility of negative returns this year. With tax-equivalent yields of 6.0% (or meaningfully higher for residents in high-tax states who invest in corresponding state funds), municipals offer great value compared with other fixed income sectors and potentially even equities, especially with the odds of a recession increasing.

This movement in tax-exempt credit spreads was more technically driven, as it occurred with municipal balance sheets stronger than they've been in two decades and rainy day funds at all-time highs, leaving states well prepared to weather an economic slowdown or contraction.

Note: Chart represents change in yields above U.S. Treasuries of similar duration for U.S. corporate bonds, and the difference in yields between AAA and BBB rated segments of the municipal market.

Notes: State fiscal years typically run from July 1 to June 30. Rainy day funds are shown as a percentage of general fund expenditures. The percentage for FY 2022 is estimated as of October 18, 2022.

Thus, we believe the municipal bond market has already broadly priced in a recession. Unlike prior economic contractions, this time it will be downgrade activity that catches up to current spread pricing, not the other way around.

Christopher Alwine is global head of Credit and Rates, where he oversees portfolio management and trading teams in the United States, Europe, and Asia-Pacific for active corporate bond, structured product, and emerging markets bond portfolios. He joined Vanguard in 1990 and has more than 20 years of investment experience.

Mr. Alwine was previously head of Vanguard's Municipal Group. There, he led a team of 30 investment professionals who managed over $90 billion in client assets across 12 municipal bond funds. He has served in multiple roles throughout his career in the Fixed Income Group. His experience includes trading, portfolio management, and credit research. Mr. Alwine's portfolio management experience spans both taxable and municipal markets, as well as active and index funds. He is also a member of the investment committee at Vanguard that is responsible for developing macro strategies for the funds.

Paul Malloy is head of municipal investment at Vanguard. Previously, he was head of Vanguard Fixed Income Group, Europe. In this role, Mr. Malloy managed portfolios that invested in global fixed income assets. He also oversaw Vanguard's European Credit Research team. Mr. Malloy joined Vanguard in 2005 and the Fixed Income Group in 2007 and has held various portfolio management positions in Vanguard's offices in the United Kingdom and the United States. In past roles, he was responsible for managing Vanguard's U.S. fixed income ETFs as well as overseeing a range of fixed income index mutual funds.

*For new-issue agency and corporate bonds, we may receive a fee concession. Trading limits and minimum investments may apply. See the Vanguard Brokerage Services commission and fee schedules for full details.

All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss. Bonds are subject to the risk that an issuer will fail to make payments on time and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments. Investments in bonds are subject to interest rate, credit, and inflation risk.

Vanguard Brokerage Services (VBS) has provided availability to the alternative trading systems operated by Tradeweb Markets LLC ("Tradeweb") and to other content provided by Tradeweb. Tradeweb provides access to certain municipal bond information from DPC DATA. Tradeweb and DPC DATA are third parties and are not affiliated with VBS. While VBS provides access to Tradeweb's alternative trading systems, VBS has no control over actions taken by Tradeweb.

Important Note: This website is not an offer to sell or the solicitation of an offer to purchase bonds or notes. Bonds or notes may only be purchased through a broker and through an official statement.

[If] prevailing interest rates are increasing, older bonds become less valuable because their coupon payments are now lower than those of new bonds being offered in the market. The price of these older bonds drops and they are described as trading at a discount,

The ETF tracks the performance of the Bloomberg U.S. Aggregate Bond Index, which measures the entire U.S. investment-grade bond market. The ETF uses a representative sampling indexing strategy to mimic the index without holding every bond. As a result, the fund has 10,477 holdings compared to 12,364 for the index.

Investment grade bonds have outperformed when there is a flight to quality, especially during periods of equity market volatility. The five largest declines in the S&P 500 Index since the global financial crisis all saw AGG post better returns,

Investors who prefer their bond holding in mutual fund form can opt for VBTLX, which tracks the Spliced Bloomberg U.S. Aggregate Float Adjusted Index. With more than 10,000 underlying securities, this fund offers highly diversified exposure to U.S. investment grade bonds. Similar to the previous ETFs, this fund has an intermediate duration of 6.5 years and an average yield to maturity of 4.6%. Sixty-seven percent of the fund is held in AAA-rated U.S. government Treasurys and agency bonds, with 14% in BBB-rated investment grade corporate bonds. To purchase VBTLX, investors need to fork over a minimum investment of $3,000. The fund charges an expense ratio of 0.05%.

Many of the bond funds profiled earlier have intermediate durations. When interest rates rise sharply, as they did in 2022, these funds can lose value. For retirees, this can be risky, especially if equities fall at the same time. To lower this risk, investors can pair the previously mentioned bond funds with an ultra-short-term Treasury ETF like BIL. This ETF tracks the Bloomberg 1-3 Month U.S. Treasury Bill Index, which provides a combination of very low interest rate and credit risk. In 2022, BIL ended the year in the green with a 1.4% gain thanks to these characteristics. The ETF costs an expense ratio of 0.135% and is extremely liquid, with a low bid-ask spread and high daily trading volume. 041b061a72


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