Corporate bonds delivered flat to slightly negative returns during the third quarter of 2014. Long-term Treasury interest rates declined to their lowest levels in more than one year but rose above their late-August lows in September. Short- and intermediate-term Treasury note yields increased as investors began to anticipate the onset of Federal Reserve rate hikes around mid-2015. The central bank continued tapering its asset purchases by $10 billion increments following its monetary policy meetings and is poised to stop its purchases in October.
The Corporate Income Fund returned −0.03% in the quarter compared with −0.08% for the Barclays U.S. Corporate Investment Grade Bond Index and −0.14% for the Lipper Corporate Debt Funds BBB-Rated Average. For the 12 months ended September 30, 2014, the fund returned 7.75% versus 6.77% for the Barclays U.S. Corporate Investment Grade Bond Index and 6.81% for the Lipper Corporate Debt Funds BBB-Rated Average. The fund's average annual total returns were 7.75%, 7.00%, and 5.63% for the 1-, 5-, and 10-year periods, respectively, as of September 30, 2014. The fund's expense ratio was 0.63% as of its fiscal year ended May 31, 2014.
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Current performance may be lower or higher than the quoted past performance, which cannot guarantee future results.
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Our security selection contributed the most to portfolio performance during the three-month period, while our management of maturities was also beneficial. Our positions in the consumer cyclicals, energy, and transportation sectors aided results, but our financial and health care holdings weighed on performance. Our duration strategy (a measure of a bond portfolio's sensitivity to changes in interest rates) boosted relative results, while our overall sector allocations were negative, due primarily to a large overweight to the health care sector.
Considering the low absolute level of yields and the Fed's intent to move rates higher in 2015, we remain guarded about overextending ourselves for yield alone. Short-term securities remain most at risk for a sell-off when the Fed begins to tighten monetary policy, but longer-term corporates are also vulnerable. The precise timing of the Fed's move is uncertain, as it will need to be cautious as it transitions from a period of extraordinary easing to one of even, gradual tightening. The central bank does not want to act too quickly and slow the economy back into a recession. The economic data in the months ahead should provide us with greater clarity as to the Fed's timing and pace, and we expect this period to be a critical time for fixed income markets.