With the Federal Reserve's zero interest rate policy advancing into a sixth year, short-term interest rates continued to trade in a narrow range as investor demand for incremental yield persisted. With money market funds paying near 0% returns, many investors have been seeking out incremental yield in the short-term bond space, that area of the yield curve from one to three years in maturity. This increased demand for yield has put pressure on the level of interest rates overall and caused yield spreads to narrow.
The Ultra Short-Term Bond Fund returned 0.30% in the quarter compared with 0.05% for the Barclays Short-Term Government/Corporate Index. For the 12 months ended June 30, 2014, the fund returned 0.70% versus 0.25% for the Barclays Short-Term Government/Corporate Index. The fund's 1-year and Since Inception (12/03/2012) average annual total returns were 0.70% and 0.42%, respectively, as of June 30, 2014. The fund's expense ratio was 0.61% 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.
Share price, principal value, and return will vary and you may have a gain or loss when you sell your shares.
We took advantage of the opportunity to add some yield to the portfolio. Investment-grade bonds, which make up the bulk of the portfolio, traded in a similar fashion to Treasuries. Persistent demand for income resulted in tightening credit spreads and lower yields. Despite an active corporate bond calendar, new issuance was well received, with strong investor demand that allowed most issuers to re-price their bonds at lower yield levels. Still, we found opportunities to add to our investment-grade corporate bond positions during the quarter. Banks, the largest issuer of investment-grade corporate bonds, constitute our largest sector allocation, followed by insurance, automotive finance, and utilities.
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 if and when the Fed begins to tighten monetary policy. Market indicators suggest that the Fed will tighten about 75 basis points (0.75%) in 2015 and another 100 basis points in 2016. The Fed 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 an interesting time for fixed income markets.