The PGIM team also likes commercial mortgage-backed securities, which make up just over one-third of the portfolio. Collins says they yield more than 200 basis points over a comparable Treasury. But CMBS is not without its warts. Some securities issued five years ago were heavy in retail, and Collins notes, “We tried to steer away. Apartments have done incredibly well, but some of that is overbuilt, and we’re careful about that.” Lodging is a property type the team favors now.

The fund also has around 20% of its portfolio in investment-grade corporate bonds, mostly in the one-to-five-year range, and Collins has arranged that part of the portfolio in a way that resembles a typical bond ladder. Investment-grade bonds are less volatile than high-yield corporates, and they provide the portfolio with a measure of stability. Collins notes that this type of portfolio hasn’t experienced an annual loss since 1994 when the Fed unexpectedly raised rates. He particularly likes financials now. Banks have been heavily regulated since the financial crisis, and their risks have been reduced accordingly. He also likes some consumer-oriented sectors, health care and telecom. Collins’ sector weightings reflect his bullishness on the consumer.

Moreover, ultra-short-term corporates (“commercial paper”) are trading at attractive prices because of the SEC’s new regulations on money market funds. As more money market instruments are purely invested in government securities, they’ve had to sell off commercial paper, causing it to trade at attractive prices.

This fund is in the top 10% of the Morningstar category for the three-year period ending in March 2017, but it wobbled a little more than the others highlighted here during the credit hiccup of late 2015. The fund dropped 0.18% in the second quarter of that year, 0.34% in the third and 0.47% in the fourth.

Another fund that likes investment-grade corporates and commercial paper is the heavyweight in the category, the $40 billion Lord Abbett Short Duration Income Fund (LLDYX). Like his peers at PGIM, manager Andrew O’Brien, speaking to Financial Advisor, said that money market reform has left a lot of commercial paper “without a natural home.”

Short-term bond managers might also see a noteworthy opportunity in asset-backed securities. O’Brien says this is a liquid asset class where credits associated with commodities have done well for the past year. The fund tends to use “AAA”-rated asset-backed securities the way other funds use Treasurys—as something to hold onto while they wait for better opportunities to present themselves. O’Brien views these securities as safe, and they’re providing a modest yield pickup right now—Libor plus 15 to 25 basis points. The fund has roughly 15% of its assets in ABS now.

The fund exchanged a substantial amount of high-yield exposure for its current investment-grade stake. At its peak, the fund had 24% of its assets in high-yield bonds; now high yield is 10% of the portfolio. High-yield bonds tumbled at the end of 2015, and came roaring back throughout 2016. O’Brien notes that high yield is not as compelling as it was six months ago.

He also notes that the fund’s size isn’t a problem because of its diversification. Having $40 billion in one sector might be burdensome, but $25 billion in investment-grade corporates and $10 billion in CMBS is manageable. O’Brien says, “CMBS is the most size-constrained area, but when we look at what percentage of the fund is there, we realize we could probably have two times the amount of assets there without a problem.” There are also advantages to being big. O’Brien notes that the fund can provide liquidity, swooping in and buying a block of assets from a motivated seller in a way that others can’t.

Regarding the 25% slug in CMBS, O’Brien notes that the asset class is slightly less compelling now, but still decent. The fund has participated in deals that places it high in the capital structure. There are some challenging fundamentals, but valuations are still reasonable. The fund is also participating in some concentrated deals—a hotel chain, for example—where some diversity is lost but the underwriting standards are tighter.

Among corporates, the fund is partial to financials, and also has a big energy overweight. Bank lending standards are much tighter now, so “BBB”-rated banks are still very solid. It’s harder for banks to be as profitable as they were before, but that hurts the equity holders rather than debt holders.

For those concerned about the credit risks the fund takes, O’Brien noted that it held up well in 2008 when it lost 0.42% and wound up in the top half of the Morningstar short-term bond category. The next year, the fund screamed back with a 17% return, good enough to land it in the top 4% of the category. The fund takes some risks, but it has a proven ability to handle them well.

While DoubleLine, Lord Abbett and PGIM take some risks, a fourth fund, the Metropolitan West Low Duration Bond Fund (MWLIX), is easing off the gas pedal. The fund has 26% of its portfolio in U.S. government bonds, which is nearly double the average exposure of funds in Morningstar’s short-term bond category. Also, the fund has another 8% of its portfolio in cash.

Longtime manager Tad Rivelle thinks we’re late in the credit cycle and investors generally aren’t being compensated for taking credit risk. Rivelle quotes Benjamin Graham in describing bond investing as a kind of “negative art” that’s designed to avoid losses or bad outcomes more than gun for gains. And if that’s normally the case with bonds, it’s especially the case now.

Still, Rivelle has made some moves to earn investors a decent yield. Although he owns almost no high yield and emerging markets debt, he owns corporate bonds, mostly utilities and financials and some consumer staples. Banks are now much more regulated than they were before the financial crisis.

Rivelle has another 7%-8% of the portfolio in asset-backed securities—specifically, U.S. government guaranteed student loans. These are floating-rate loans with uncapped features on their yields providing good inflation protection.

Still another roughly 8% of the portfolio is in CMBS. This includes loans on different property types, and Rivelle owns very highly rated tranches that he says would only be impaired in the event of a 30% to 40% loss on the underlying loans.

Like other bond managers, Rivelle owns some subprime non-agency mortgages dating from the financial crisis. Those that still exist represent good value, in his opinion. The borrowers of remaining loans are making their payments, and the bonds sell at discounts. According to Rivelle, “The credit curing process continues to unfold. So there are defensive securities that can provide between 2% and 5% without bearing much risk.”

Lastly, Rivelle is trying to arbitrage the appetite of foreign investors to own U.S. dollars. Specifically, he is buying short-term Japanese sovereign debt and hedging the currency exposure with a forward contract. That provides a 1.25% to 1.50% annualized return for a 90-day investment for taking Japanese sovereign risk.

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