The average core bond fund — one that invests at least 85% of its assets in investment-grade bonds — fell 2% in 2013 through Friday, including reinvested interest.
In contrast, the Standard and Poor's 500 stock index gained 31.9% through Friday, including reinvested dividends.
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Bond prices fall when interest rates rise, which accounts for much of bond funds' suffering. The bellwether 10-year Treasury note closed Friday at 3.01%, 3.00%, which was up from 1.76% at the start of 2013 and the highest since July 2011.
Not all bond funds languished, although none fared as well as the S&P 500. Best bond categories:
• High-yield bond funds, up an average 6.7%, according to Lipper, which tracks the funds. These funds invest in low-quality corporate IOUs, often called junk bonds.
• Loan-participation funds, up an average 5.4%. These funds invest in variable-rate bank loans, which makes them somewhat more resistant to rising interest rates.
• Multi-sector income funds, up 1.6%. The utility outfielders of the bond universe, these funds can invest in many different types of bonds, both in the U.S. and abroad.
A few types of bond funds got hit hard:
• Emerging markets bond funds fell 9.2%. These funds invest in long-term bonds issued by companies or governments in less-developed countries, such as Brazil and Russia. Lower commodity prices put a financial strain on some of these nations, and a higher U.S. dollar pushed prices lower, as well.
• Inflation-protected bond funds fell 7.6%. These funds shield investors from inflation, which didn't occur in the U.S. in 2013. The consumer price index rose just 1.2% the 12 months ended November, according to the Bureau of Labor Statistics.
• General U.S. Treasury funds. Treasury ! yields were kept artificially low by the Federal Reserve in a bid to boost the economy. As the Fed started to take its foot off the monetary gas pedal, rates rose, pushing bond prices down. The bonds paid little interest to offset the price declines.
If the economy continues its weak recovery, interest rates should continue to rise throughout 2014, pushing bond prices down further. Bank of America Merrill Lynch expects the yield on the 10-year Treasury to hit 3.75% by the end of 2014, which will mean more pain for bond-fund investors, but slightly higher yields, as well.
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For most investors, the best way to protect against rising interest rates is to invest in funds that buy short-term bonds, rather than long-term ones. Fund companies typically publish a statistic for bond funds called duration, which measures a fund's sensitivity to rising rates. A fund with a duration of 3, for example, will see its share price fall 3% for every 1 percentage-point gain in interest rates.
Investors have yanked an estimated net $77 billion from bond funds this year, according to the Investment Company Institute, the funds' trade group. But more could be coming out: In the past five years, investors have flooded the funds with $995 billion in new money.
Major bond funds' 2013 performance
How the five largest bond funds, ranked by assets, fared in 2013 by total return (interest, gains reinvested through Friday):
PIMCO Total Return (PTTRX): -2.0%
Vanguard Total Bond Market Index (VBMFX): -2.3%
Templeton Global Bond (TPINX): 2.0%
Vanguard Short-Term Investment-Grade (VFSTX): 1.0%
Vanguard Short-Term Bond Index (VBISX): 0.1%
Source: Lipper
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