Corporate bonds delivered positive returns during the fourth quarter of 2014. Long-term Treasury bonds performed best, as long-term interest rates and inflation expectations tumbled with oil prices. U.S. government bond yields looked appealing versus yields of their eurozone and Japanese counterparts. Investment-grade corporate, mortgage-backed, and municipal securities also produced solid gains, but asset-backed securities trailed. High yield bonds fell as credit spread, the yield difference between high- and low-quality bonds with comparable maturities, widened, which indicated growing concerns about borrowers' ability to service their debt.
The Corporate Income Fund returned 1.51% in the quarter compared with 1.77% for the Barclays U.S. Corporate Investment Grade Bond Index and 1.63% for the Lipper Corporate Debt Funds BBB-Rated Average. For the 12 months ended December 31, 2014, the fund returned 8.25% versus 7.46% for the Barclays U.S. Corporate Investment Grade Bond Index and 7.07% for the Lipper Corporate Debt Funds BBB-Rated Average. The fund's average annual total returns were 8.25%, 6.96%, and 5.55% for the 1-, 5-, and 10-year periods, respectively, as of December 31, 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.
Share price, principal value, and return will vary and you may have a gain or loss when you sell your shares.
Our security selection was the major contributor to fund performance during the reporting period. We were most heavily weighted in consumer cyclical bonds, significantly overweight in the sector versus the Barclays benchmark, which helped boost our relative return. On a negative note, our overall sector allocations served as a drag on results. We were overweight in basic industry companies, which trimmed relative performance during the period. Underweights in banking, capital goods, technology, and telecommunication services were also detrimental. However, our underweights in the electric utilities, energy, and health care sectors offset some of the weakness in the other areas.
The Federal Reserve kept short-term interest rates low but ended its monthly asset purchases in October. In mid-December, the central bank indicated its intention to be "patient" with regard to raising short-term interest rates. We expect rate hikes to commence in mid-2015. Regulators have expressed fears that rising rates and falling bond prices in the coming months could trigger outflows from bond funds, putting a strain on the market. Stricter regulations stemming from the 2008 financial crisis have altered the landscape for fixed income funds, resulting in a change of strategy in some cases. On the positive side of the equation, declining liquidity creates opportunities for fixed income investors. Less liquid bonds become attractive when issuers are fundamentally sound and investors are adequately compensated with attractive yields.