Bond prices fell and yields rose for most of the third quarter as investors anticipated that the Federal Reserve would start moderating its monetary stimulus. But on September 18, the Fed unexpectedly announced that it would maintain the current pace of its monthly asset purchases. The delay in the Fed's tapering plans lifted bond market sentiment. Treasury prices rallied and yields declined after the Fed's announcement; however, by quarter-end, longer-term Treasury yields were still higher than they were on June 30. Short-term Treasury yields inched lower over the quarter as the yield curve steepened, with the largest rate increases occurring in the longest maturities of 20 years and more. Agency mortgage-backed securities, another beneficiary of the Fed's stimulus program, turned in respectable returns.
The U.S. Treasury Intermediate Fund returned 0.35% in the quarter compared with 0.47% for the Barclays U.S. 4−10 Year Treasury Bond Index and −0.62% for the Lipper General U.S. Treasury Funds Average. For the 12 months ended September 30, 2013, the fund returned −2.98% versus −2.49% for the Barclays U.S. 4−10 Year Treasury Bond Index and −5.83% for the Lipper General U.S. Treasury Funds Average. The fund's average annual total returns were −2.98%, 4.79%, and 4.37% for the 1-, 5-, and 10-year periods, respectively, as of September 30, 2013. The fund's expense ratio was 0.49% as of its fiscal year ended May 31, 2013.
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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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The fund invests at least 80% of its assets in Treasuries but maintains modest positions in securities backed by the U.S. government, including Treasury inflation protected securities (TIPS) and Ginnie Mae mortgage-backed securities (MBS). Our TIPS allocation provides some inflation protection for our Treasury holdings, while our MBS holdings provide added yield over Treasuries, decent liquidity, and diversification for the fund. Both of these out-of-benchmark allocations helped quarterly returns. However, our allocations to longer-dated securities weighed on performance as the yield curve steepened over the period. September was a strong month for agency MBS due to favorable supply and demand trends supporting the sector. We took advantage of this strength by reducing our Ginnie Mae holdings to end the quarter with a roughly 7.5% allocation. To protect shareholders from higher interest rates, the fund's duration, which measures the sensitivity of a bond fund's price to a change in interest rates, is underweight compared with the benchmark.
The Fed's September announcement implied that liquidity will not be removed as quickly as markets had expected and that interest rates will likely stay lower for longer. This has placed downward pressure on Treasury yields and should support higher-risk assets in the near term. Over the longer term, however, we expect rates to gradually rise as an improving global economy and less accommodative Fed policy call for more normal yield levels. Treasury bonds have proven to be an effective hedge against market turmoil, but their long-term nature and historically low yields have subjected holders to greater interest rate risk in recent years. We have some leeway to manage interest rate risk by adjusting the fund's duration, but our mandate of investing in intermediate-term securities puts the fund at risk of generating negative returns in the event of rising interest rates.