(PUB) Investing 2015

20

A Year Full of Surprises Income Strategist | Sarah Bush

and had grown to the largest sector in the high-yield market. With oil prices plummeting, energy-related high-yield names got slammed. All in all, the category had its worst year since 2008 , and a number of funds lost money in 2014 . Relatively conservative funds, such as Vanguard High-Yield Corporate VWEHX , held up well, while some more-adventurous funds with meaningful equity stakes, including Fidelity Capital & Income FAGIX , enjoyed solid gains. Challenges Abroad With conflict between Russia and Ukraine dominating headlines for much of the year and the recent plunge in energy prices, there were plenty of potholes to avoid in global bond markets. The situation intensified in the first weeks of December as the ruble tanked and Russian sovereign debt took a sharp tumble. Meanwhile, a decisive rally in the dollar against almost all major currencies meant trouble for funds with meaningful exposure to nondollar currencies. That led to a particularly wide spread in returns for funds in the world-bond Morningstar Category, with funds sporting gains of up to 15% and losses as steep as 5% in 2014 . Templeton Global Bond TPINX , which sports stakes in Ukraine, Russia (albeit small), and Poland, landed near the world-bond category midpoint with a 1 . 6% gain. Munis Rebound Munis were one of the hardest-hit sectors in 2013 , thanks in part to a run of bad headlines out of Detroit and Puerto Rico. However, the recovery in Treasury yields stood the muni market in good stead in 2014 . Supply remained relatively muted, while Morningstar’s muni-bond categories enjoyed $25 billion in net inflows for the year to date through November, providing a supportive technical environment for the sector. Meanwhile, headline risk faded as Detroit exited bankruptcy and many municipalities saw improving finances. Even Puerto Rico, whose fate is far from clear given the territory’s cash-strapped fiscal state and continued economic stress, saw a rally in its bonds. Long-term muni funds, such as Franklin Federal Tax-Free Income FKTIX , enjoyed a nice bounceback during the year. œ Contact Sarah Bush at sarah.bush@morningstar.com

“Prediction is very difficult, especially about the future.” Neils Bohr

Coming into 2014 , prognosticators had the fixed- income markets all figured out. Many posited that it would be a rough year for U.S. Treasuries and other rate-sensitive bonds as the Fed unwound its bond-buying program. Meanwhile, riskier assets, including junk bonds and bank loans, seemed poised to outperform against the backdrop of manageable corporate-debt levels, decent economic growth, and strong investor appetite. Munis were a trouble spot against the backdrop of bad news out of the Motor City and Puerto Rico, while many thought of Russia as a relatively high-quality name in the emerging-markets arena. An Unanticipated Bond Rally The year showed once again how hard it is for fixed- income managers to get interest-rate bets right, especially over the short term. Against the backdrop of geopolitical risk, a softer-than-expected global economic outlook, and pension fund rebalancing, long U.S. Treasuries enjoyed an unexpectedly strong rally. That caught many intermediate-term bond managers, who had positioned their funds for an increase in bond yields, flat-footed. But some, including the team at Western Asset Core Plus Bond WACPX , which has a Morningstar Analyst Rating of Silver, benefited from a decision to favor longer-maturity bonds. Junk Bonds in Trouble After starting the year strong, things turned ugly for high-yield bonds in the second half of the year. Energy companies, driven by a surge in shale oil drilling, had issued a ton of cheaply priced debt in recent years’ borrower-friendly high-yield markets It’s fair to say the script played out differently. Here are several of the biggest stories from 2014 .