The fixed income market ended mostly lower during the second quarter of 2015. Longer-term Treasury yields increased but finished June below their highest levels of the quarter as fears that Greece would exit the eurozone prompted investors to favor the safety of U.S. government bonds. The Federal Reserve refrained from raising short-term rates but signaled that rate hikes will commence by the end of the year. In the investment-grade universe, Treasuries fared worst, especially longer-term securities. Short-term bonds were basically flat with little change in net yields during the quarter.
The Short-Term Bond Fund returned −0.05% in the quarter compared with 0.13% for the Barclays 1−3 Year U.S. Government/Credit Bond Index. For the 12 months ended June 30, 2015, the fund returned 0.32% versus 0.93% for the Barclays 1−3 Year U.S. Government/Credit Bond Index. The fund's average annual total returns were 0.32%, 1.40%, and 2.96% for the 1-, 5-, and 10-year periods, respectively, as of June 30, 2015. The fund's expense ratio was 0.52% as of its fiscal year ended May 31, 2014.
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Our allocation to investment-grade corporate bonds had been beneficial earlier, but the segment came under pressure along with other high-quality bonds. Technical factors supporting investment-grade bonds deteriorated to some degree, and the valuations on these securities appeared a bit high at the end of the period. Our credit selection was modestly positive. We continued to hold an out-of-benchmark allocation to mortgage-backed securities, which performed well over the year. Our holdings in Treasury inflation protected securities (TIPS) did not perform well, since inflation remained moderate thanks to the strong dollar and declining energy prices. TIPS have not fared well for more than a year in a low-inflation environment, although there is some indication that inflation could accelerate in the coming months.
Considering the current strength in U.S. employment growth and some signs of a pickup in inflation, we believe the Fed will begin to raise short-term interest rates later this year. Longer-term rates have already begun to rise in anticipation of such a move, leading to greater volatility in the fixed income market. With expected improvement in economic growth after a weak first quarter, we believe these trends will continue. We have been offsetting allocations to volatile sectors with more liquid assets such as Treasuries, agency bonds, asset- and mortgage-backed securities, and higher levels of cash. 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.