Short-term bond funds are the folic acid of investments; a supplement that will give you a barely measurable albeit positive return. The best-performing short-term bond funds bear a payoff so small that you’ll have to commit almost all your principal to see an appreciable difference. But given their objective, short-term bond funds work as well as anything. “Preservation of capital” is the preferred term here. Short-term bond funds are for people who have already succeeded to the point where not losing is more important than winning.

Playing Defense, Not Offense

Short-term bond funds don’t exist to make you wealthy. That’s what Micron Technology, Inc. (MU) stock is for. (Kidding! It’s down more than half this year.) Short-term bond funds are supposed to preserve your wealth. As a category, such funds are up .48% this year, which beats losing a much higher percentage to taxes. And if a formula works on Wall Street, it’ll be repeated, which is why there are more than 540 short-term bond funds available to the public. The funds are relatively easy for investment companies to create, and there are plenty of debt offerings to select fund components from.

The best-performing short-term bond fund over the past year has been the Guggenheim Limited Duration Fund, up 2.48%. At that rate, you could double your money in…almost certainly more time you have left on this realm, once you account for inflation. But again, large compounded returns are not what short-term bond fund investors ought to be looking for.

Like many funds of its ilk, the Guggenheim Limited Duration Fund invests a plurality of its money in collateralized loan obligations, which are enjoying a resurgence after investors ran away screaming during the subprime crisis of the late aughts. CLOs derive from large business debt, rather than mortgage debt, which makes them slightly more palatable to risk-averse investors. Guggenheim feels confident enough in CLOs that they comprise more than 1/3 of the fund.

The caveats about mortgage debt being stated, the Limited Duration Fund’s next largest component is…mortgage-backed securities. Are the Guggenheim fund managers insane, or foolhardy, or just plain ignorant? None of the above. The mortgage-backed securities in question are classified as “non-agency,” meaning that they are not sponsored by secondary market lusus naturæ Fannie Mae nor Freddie Mac. Instead the securities are backed by private companies: real private companies, with shareholders to answer to, as opposed to government-sponsored entities that destroy value and don’t even have to answer for it. Non-agency mortgage-backed securities make up more than a quarter of the fund’s assets.

The Guggenheim Limited Duration Fund’s largest individual component, as opposed to largest investment type, is…yet another Guggenheim fund, the Strategy I Fund. The former fund has no load, and a fairly substantial expense ratio of more than ½%. If you want in, for an opportunity to get your hands on a piece of that sweet 2.48% annual return, you need to pony up a mere $2 million.

Entry-Level Preservation

For better results in the short term, fittingly for short-term bond funds, let’s look at the best-performing fund in this category over the last 3 months. That’d be American Funds’ Intermediate Bond Fund of America, which has returned .91% in the last quarter. Unlike its Guggenheim contemporary, with its yen for slightly riskier and lower-quality bonds, the Intermediate Bond Fund of America loads up on both government and corporate bonds of a higher rating. And the Intermediate Bond Fund of America’s expense ratio is exactly half of the Guggenheim Limited Duration Fund’s. Those 27 basis points can make a big difference; in fact, they account for most of the variation between the two funds’ returns over the past 12 months.

The Intermediate Bond Fund of America is made mostly of T-bonds and T-notes, which are notorious for being about the safest securities you can commit money to. This particular fund is a profusion of components, 627 in total, and most of those fixed-income securities. Top components are Treasurys maturing in 2019 and paying 1½%; Treasurys maturing in 2019 and paying 1 5/8%, Ginnie Mae issues paying 4% and maturing in 2045, more Treasurys maturing in 2019 and paying 1 5/8%, etc. Wags might say it’s an uninspiring recipe, but it works. The fund doesn’t invest in anything below an A- rating. And unlike Guggenheim’s fund for the affluent, you can buy in to American Funds’ offering for as little as $250[11]. If trends continue, your $250 investment could be worth a sweet $254.93 by this time next year. Don’t spend all your gain in one place. (See also: Do long-term bonds have a greater interest rate risk than short-term bonds?

The Bottom Line

Short-term bond funds aren’t so much for the conservative investor, as for the successful investor (which implies having been aggressive somewhere along the line) with conservative objectives. If you’re comparing one short-term bond fund to the next, remember to look beyond past performance. Expense ratios, minimum contributions and tax implications are far more important than a basis point or two of movement.

Disclosure: The author does not have any holdings in the funds discussed.



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