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3 Great Mutual Funds to Earn 2% - 4% on Investment-Grade Bonds

With yields low and downside risk climbing, look for funds that are flexible.

Yields on high-quality corporate bonds look much more appealing than they did a year ago. The Bloomberg Barclays U.S. Aggregate Bond index—a proxy for the high-quality bond market—yields 2.6%, well above its 52-week low of 1.8%. Also attractive these days are mortgage-backed securities—pools of commercial real estate loans or residential mortgages.

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Risks to your money. The bonds’ safety net is their dependable coupons, or annual interest rates. But yields are low today, so those payments “don’t give you as much protection” as they once did, says William Kohli, chief investment officer for fixed income at Putnam Investments. A weakening economy and credit-rating downgrades could also depress bond prices.

How to invest. Avoid long-term bonds and emphasize funds with the flexibility to invest in wide swaths of the market. Metropolitan West Unconstrained Bond (MWCRX, 2.3%) holds corporate bonds, Treasuries and mortgage securities. With an average duration of 1.5 years, the fund keeps its rate sensitivity low.

DoubleLine Total Return Bond (DLTNX, 3.4%), a member of the Kiplinger 25, the list of our favorite no-load mutual funds, focuses on residential mortgage securities, a specialty of comanager Jeffrey Gundlach. A duration of four years makes the fund somewhat sensitive to rates. But with a yield north of 3%, the fund’s income should keep returns in positive territory.

Pimco Income Fund (PONDX, 3.5%), another Kip 25 member, holds corporate and government bonds, mortgages and some riskier bonds, such as emerging-markets debt. Income is a bit more vulnerable to ratings downgrades than the typical high-grade bond fund. And it has a moderate average duration of 3.6 years. Long term, it has proved “adept at handling both challenges and opportunities,” says Morningstar.

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