Short-term bonds delivered slightly negative 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 spreads, 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 Short-Term Bond Fund returned −0.09% in the quarter compared with 0.17% for the Barclays 1−3 Year U.S. Government/Credit Bond Index. For the 12 months ended December 31, 2014, the fund returned 0.60% versus 0.77% for the Barclays 1−3 Year U.S. Government/Credit Bond Index. The fund's average annual total returns were 0.60%, 1.66%, and 2.99% for the 1-, 5-, and 10-year periods, respectively, as of December 31, 2014. The fund's expense ratio was 0.52% as of its fiscal year ended May 31, 2014.
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During the past few months, we have been reducing our overweight to corporates in favor of asset-backed securities (ABS) and commercial mortgage-backed securities (CMBS). Within these sectors, we have been participating in deals that offer a pickup in yield and a higher credit quality rating than some BBB corporates. Our move into both types of securities represents an improvement in quality, with asset classes that exhibit far less volatility while giving up some yield in the former instance. Our ABS purchases were in AAA rated credit cards and autos (mostly prime), and an occasional A rated timeshare at very attractive levels. The CMBS segment is also an increase in quality offering a bit less volatility, but with better yields than those provided by ABS.
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.