Best Intermediate-Term Bond Funds for the Long Term

Fixed-income investors face the potential of rising rates in the near future.

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In Pictures: 10 Best Intermediate-Term Bond Funds for the Long Term

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U.S. News is releasing a series of stories highlighting top-rated mutual funds according to various categories. These funds have performed well over the long term, are rated highly among the industry's analysts, and have low minimum investments, making them accessible to all investors—big or small. This is the final piece in a series of stories highlighting 10 categories that make up U.S. News's 100 Best Mutual Funds for the Long Term.

Common wisdom says that over long periods of time, stocks generally produce higher returns than bonds. But over the past decade or so, fixed-income has won out. The S&P 500 stock index has returned an annualized 2 percent over the past 10 years, versus an average annual gain of 6 percent for the Barclays Capital U.S. Aggregate Bond Index over the same time period. Bonds are ahead for a number of reasons, including falling interest rates.

But rates could move higher in the near future. When rates rise, the prices of bonds fall—and that spells trouble for many types of bond funds, including intermediate-term bond funds. "Intermediate bond funds have the challenge of potentially rising interest rates and currently pretty low yields," says Russel Kinnel, Morningstar's director of mutual fund research. "You have meager yields in the 3 percent range, and you might suffer capital losses if interest rates go up. That's not really ideal."

But Kinnel says intermediate-term bond funds are meant to be core portfolio holdings, so you shouldn't abandon them. These funds invest in some of the most high-quality sectors of the bond market, including treasuries, mortgage-backed securities, and corporate bonds, which are all key ingredients of a diversified fixed-income portfolio. The good news, Kinnel says, is that the category is littered with proven funds that have managers with long track records.

With that in mind, here are U.S. News's best intermediate-term bond funds for the long term:

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TCW Total Return Bond (symbol TGLMX). A team from MetWest Asset Management took the reigns of this fund in 2009, after longtime manager Jeffrey Gundlach was fired. Last year, management announced that it could invest up to half of the fund's asset in junk bonds. The reasoning: Following the credit crisis in 2008, many mortgage-backed bonds have been downgraded to ratings below investment-grade. Mortgage-related securities are management's speciality, and a great deal of the fund's assets currently reside in that sector. Over the past 10 years, the fund has returned an annualized 7 percent. It yields 6.2 percent, and its annual fees are 0.44 percent.

TCW Core Fixed-Income (TGCFX). Gundlach also previously ran this fund, which MetWest now manages. The fund is also heavy in mortgage-backed securities, many of which are junk-bond rated. Since becoming manager in late 2009, Tad Rivelle has introduced commercial mortgage-backed securities into the fund, and has increased its exposure to financial-sector corporate bonds. Over the past 10 years, the fund has returned an annualized 8 percent. It yields 3.5 percent, and its annual fees are 0.44 percent.

Delaware Diversified Income (DPDFX). Management at this fund takes a global approach to investing in a diversified mix of fixed-income securities. Almost half of the fund's assets are invested in U.S. corporate bonds, and about 20 percent of assets reside abroad in corporate and sovereign—or foreign government—bonds. The fund has returned an annualized 8 percent over the past 10 years. It yields 3.6 percent, and its annual fees are 0.93 percent.

USAA Income (USAIX). Although the fund is diversified among fixed-income securities, management is currently mopping up short-term bonds in hopes that it can sell them to reinvest in longer-term securities when interest rates rise to more attractive levels. Manager Margaret Weinblatt has grown more conservative in recent months because she's concerned about rising interest rates; about 10 percent of the fund's total assets are stashed in cash. Over the past 10 years, the fund has returned an annualized 6 percent. It yields 3.3 percent, and its annual fees are 0.61 percent.