The bond market reversed course during the second quarter, with the best- and worst-performing fund categories from the first quarter essentially...

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The bond market reversed course during the second quarter, with the best- and worst-performing fund categories from the first quarter essentially switching places.

“It was a bit of a surprising quarter,” says Scott Berry, a senior fund analyst at Morningstar. “Riskier areas of the troubled bond market did well.”

Bank-loan and high-yield bonds — the two worst-performing categories during the first quarter, when each lost more than 3 percent — were the top gainers in the second quarter, while most sectors fell. Both categories have higher credit risk than government bonds.

“Bank loans got pretty cheap,” Berry says.

Bank loans were selling for between 80 and 85 cents on the dollar, Berry says. When they fail, recovery rates are usually 70 to 75 cents, so the “downside risk was limited,” he adds.

The pummeling that high-yield bonds took late in 2007 and during the first quarter of 2008 made them attractive during the most recent quarter, despite continued worries in the credit markets.

But bank-loan and high-yield bonds are still among the worst-performing bond categories for the past year.

High-yield bonds “bottomed out so much that people were willing to dip their toes into the sector,” says Tim Sanville, a senior portfolio manager at BNY Mellon.

He says high-yield and other corporate bonds gave up some of their April and May gains in June amid renewed concerns about the performance of financial firms and investment banks.

Intermediate and long-term government bonds were among the worst-performing categories during the second quarter because of fears of inflation, Berry says.

Intermediate-term government funds fell more than 1 percent, according to Morningstar. Long-term government funds declined 3 percent.

Investors feared inflation would prompt the Federal Reserve to increase interest rates, Sanville says. This would hurt prices of existing bonds.