Fixed income investors who rely on interest rate-based returns for income have been hit especially hard over the past 8 years due to quantitative easing policies. Under most economic circumstances, the yield curve slopes toward increased rates in proportion to increased duration. Prices and yields move inversely due to demand. The result of the normal yield curve shows that longer-term interest rates are more sensitive to market changes, thus pricing volatility is significantly more pronounced in 10- to 30-year bonds versus 30-day bonds.
Interest rates and bank stocks have surged in the wake of the U.S. election as market sentiment drastically improved alongside confidence in U.S. growth prospects. Long-term rates have increased as much as 40 basis points on the 10-year Treasury bond over the past month, leading to an even larger swing on the 30-year Treasury. Rising rates on shorter-term bonds, however, have been impacted less, with 1-year Treasuries moving roughly 15 basis points over the same period.
Short-term bond funds tend to perform better during periods of bond sell-offs and rising interest rates due to reduced volatility on near-term fixed income products relative to longer maturities. Due to attrition that would normally correspond with a limited maturity, turnover on shorter-term bonds would understandably be greater than on longer-term holdings, affording a shorter-term portfolio the ability to mitigate the impact of rate change cycles more quickly. Morningstar total cumulative return statistics have shown that short-term bond funds have been the only major investment fund product category to post positive total returns during the last three rate hike cycles of 1994 to 1995 (13 month +275 basis points), 1999 to 2000 (12 month +150 basis points), and 2004 to 2006 (25 month +400 basis points).
The Fidelity Short Term Bond Fund (FSHBX) is worth considering for investors seeking to hedge a portion of their portfolio.
Strategy
The Fidelity Short Term Bond Fund (FSHBX) has a Silver 3-star Morningstar rating and a relatively low 2-star risk rating. It has been consistently delivering relatively high income while preserving capital since 1986. A minimum of 80 percent of the $6.55 billion fund is invested in both domestic and international investment-grade bonds or repo agreements. To boost returns while offsetting risk, FSHBX targets its largest portfolio allocation toward AAA-rated U.S. Treasuries but is underweight relative to the Barclays U.S. 1-3 Year Government/Credit Bond Index (20 percent vs. 58 percent), while overweight higher-yielding corporates (49 percent vs. 27 percent). FSHBX’s stated policy goal is to maintain a dollar-weighted average duration of not more than 3 years.
However, while 68 percent of the portfolio is in maturities of 1 to 3 years, the goal of maximizing income while protecting capital has tilted toward some slightly longer maturities. 19.86 percent of bonds in the portfolio are 3 to 5 years, 1.84 percent are 5 to 7 years, 0.53 percent are 7 to 10 years, 1.52 percent are 10 to 15 years, 1.37 percent are 15 to 20 years, 2.71 percent are 20 to 30 years, and 4 percent are over 30 years.
Holdings
Per the fund’s strategy, FSHBX’s top 5 holdings are an assortment of U.S. Treasury notes, ranging in yield from 0.75 to 1.375 percent, accounting for 16.2 percent of the portfolio. Domestic issues make up 83.50 percent of bond holdings, with international bonds from the United Kingdom, Japan and Canada being the primary non-U.S. positions. The overall composition of the portfolio is approximately 20.3 percent U.S. Treasuries, 49.3 percent corporates, 27 percent mix of mortgage-backed and asset-backed securities, and 2.7 percent in cash. Within the corporate arena, preferred sectors include tobacco, auto, financial and banking. Notably, Ford Motor Company and Citigroup account for 1.49 and 2.05 percent of the portfolio, respectively.
Performance
With a turnover rate of over 130 percent, FSHBX has a year-to-date return of 1.85 percent and a 0.96 percent yield. From a growth perspective, a $10,000 investment would be worth $11,843 over the course of 10 years. Trailing total returns for 1 year were 1.09 percent, 0.91 percent for 3 years, 1.19 percent for 5 years, 1.64 percent for 10 years, and 2.34 percent for 15 years. Given the objective of the fund, these returns are quite respectable.
As befits its intended inoculation to market volatility, FSHBX’s past 12-month high-to-low price fluctuation has stayed +/- a total of 11 cents.
Management
Rob Galusza has run FSHBX since 2007, with Robin Foley joining him in 2008. Fostering a conservative approach, their numerical returns lag somewhat at face value, but exceed their peers’ when factoring in a risk adjustment basis. This philosophy protected FSHBX well in 2013 when Fed Chairman Bernanke spooked the market with comments that drove most rival bond funds down 0.64 percent, while FSHBX fell only 0.03 percent. Though neither had ever run a mutual fund before, Galusza and Foley had a 20-year history of collaboration at Fidelity before undertaking FSHBX.
Investment Minimums & Fees
The investment minimum is $2,500. FSHBX’s expense ratio is a low 0.45 percent versus the category average of 0.80 percent. There are no transaction fees, redemption fees or loads. Management actual fees are 0.31 percent, and management maximum fees are 0.20 percent.
Recommendation
The recent spike in interest rates was once again a reminder of why short-term bonds are useful in a portfolio. FSHBX fell 0.38 percent in November, while Fidelity Intermediate Bond (FTHRX) fell 1.83 percent and Fidelity Long-Term Treasury Bond Index (FLBIX) plunged 7.85 percent. If bond yields do not stop rising in 2017, the gap between these numbers will only grow larger. Investors should check the duration of their bond funds and be sure they are comfortable with the level of risk in their fixed income investments. Currently we have issued a Strong Buy recommendation with a ranking of 86.