Short-term bonds delivered 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 it is poised to stop its purchases in October.
The Short-Term Bond Fund returned −0.27% in the quarter compared with 0.04% for the Barclays 1−3 Year U.S. Government/Credit Bond Index. For the 12 months ended September 30, 2014, the fund returned 1.05% versus 0.77% for the Barclays 1−3 Year U.S. Government/Credit Bond Index. The fund's average annual total returns were 1.05%, 1.84%, and 3.05% for the 1-, 5-, and 10-year periods, respectively, as of September 30, 2014. The fund's expense ratio was 0.52% as of its fiscal year ended May 31, 2014.
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We added to our commercial mortgage-backed securities throughout the quarter, participating in deals that offer a pickup in yield and a AAA rating when compared with some BBB corporate bonds. We continue to look for opportunities to add asset-backed securities. Conversely, we trimmed our corporate bond exposure, as valuations in the segment have become stretched due to heavy demand and strong technical pressure. The portfolio is positioned with a modest duration (a measure of a portfolio's sensitivity to changes in interest rates) since we expect yields to move higher over time. We currently have no interest rate hedges in place and remain cautious about too much exposure to longer-term bonds, as they are likely to be most affected by rising rates.
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. The two- to five-year portion of the yield curve remains most at risk for a sell-off when the Fed begins to tighten monetary policy. 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.