Short-term bonds generated positive first-quarter returns. Longer-term Treasuries outperformed shorter-term issuance amid heightened volatility-in February, Treasuries experienced their sharpest sell-off since the "taper tantrum" in 2013. Investment-grade corporate bonds, commercial mortgage-backed securities, and high yield corporates produced good gains. The Federal Reserve prepared markets for an initial interest rate increase, which appears likely to take place sometime later in 2015. In her semiannual testimony before Congress, Fed Chair Janet Yellen said that the Fed will begin to evaluate an initial interest rate hike on a "meeting-by-meeting basis."
The Short-Term Bond Fund returned 0.73% in the quarter compared with 0.59% for the Barclays 1−3 Year U.S. Government/Credit Bond Index. For the 12 months ended March 31, 2015, the fund returned 0.98% versus 1.12% for the Barclays 1−3 Year U.S. Government/Credit Bond Index. The fund's average annual total returns were 0.98%, 1.59%, and 3.09% for the 1-, 5-, and 10-year periods, respectively, as of March 31, 2015. The fund's expense ratio was 0.52% as of its fiscal year ended May 31, 2014.
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Sector allocation decisions, especially an overweight to corporate bonds and an underweight to Treasuries, contributed to the portfolio's relative performance. Security selection contributed in selected energy-related corporate bonds, which rebounded following the fourth-quarter sell-off. Yield curve positioning also generated a positive contribution to relative results, particularly an underweight to short-term issues, an overweight to five-year securities, and a modest out-of-benchmark allocation to 10-year notes. However, our exposure to the Mexican peso was a detractor. By the end of the quarter, the portfolio was fully hedged, but our currency exposure during the period hurt our performance relative to the benchmark.
We believe that the next few months will provide greater clarity about the timing and pace of the Fed's policy tightening. Since rate increases will likely have a significant impact on the securities within our investment horizon, we have adopted a neutral duration stance relative to the benchmark, with an underweight in two-year holdings and an overweight to the five-year part of the yield curve. Duration measures a portfolio's sensitivity to interest rate changes. Our tactical allocation positioning involves offsetting holdings in volatile sectors with more liquid assets such as Treasuries, agency bonds, asset- and mortgage-backed securities, and higher levels of cash. We believe that 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.