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This Short-Term Bond Fund Provides Protection From Rising Rates

Pimco Low Duration Income fund plays defense against rising rates and delivers a decent yield.

At last, short-term bonds offer respectable yields that surpass 2%—and it only took six interest-rate hikes over three years by the Federal Reserve. With more increases to come, short-term bonds have an added bonus: Their prices sink less than those of longer-dated debt when interest rates rise (bond prices and interest rates tend to move in opposite directions). That's because short-term bonds typically have a lower duration, a measure of interest-rate sensitivity, than their longer-term counterparts.

Pimco Low Duration Income (PFIAX) boasts a duration of 1.4 years. That implies the fund's value would decline by 1.4% if rates were to rise one percentage point. By contrast, the Bloomberg Barclays U.S. Aggregate Bond index has an average duration of 5.9 years.

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Managers Daniel Ivascyn, Alfred Murata and Eve Tournier want to generate income and keep interest-rate sensitivity in check. They hunt for bonds with durations of three years or less and divide the portfolio into two groups: high-yield bonds that perform well in growing economies, and high-quality debt that will rally during weak economies. The managers are willing to take on more credit risk—that is, the risk that a bond issuer will default—than the average short-term bond fund. But riskier bonds must pay more to attract borrowers, and that helps to boost the fund's yield to 2.6%—more than the 2.4% yield of the typical short-term bond fund.

The fund takes its cue from Pimco's overarching view of the economy and the bond market. The current outlook is a cautious one, given the well-above-average length of the current economic recovery and pockets of the bond market looking rich compared with historical values. As a result, the fund's managers have grown more defensive recently and have added to the fund's positions in U.S. Treasuries and foreign government debt. On the high-yield side, the crew favors mortgage-backed securities that are not guaranteed by the U.S. government.

Earlier this year, Pimco converted the no-load, Class D shares of all of its mutual funds to A shares, which carry sales charges of 2.25% to 3.75%. To avoid the load, investors can purchase shares at Fidelity, Schwab or Vanguard for no load and no transaction fee.

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