Key Takeaways
- Emerging-market bond funds boasted the highest returns before the Iran war, but they have since become the worst-performing bond fund category.
- As the war sent interest rates higher, shorter-term bond funds, which lagged in the past year, have been among the best performers.
- Bank loan funds and ultrashort-term bond funds are the top-performing categories since the war began.
The Iran war flipped the performance of bond funds. Emerging-market and longer-term funds, which had outperformed before the war, were among those hardest hit by the bond market selloff. Meanwhile, shorter-term US bond funds moved to the front of the pack.
While the performance reflects a short period, the dynamics demonstrate the sensitivity different corners of the bond market have to expectations of higher inflation. Worries about inflation were revived by the spike in oil prices and a rise in the value of the US dollar. Before the war, inflation was seen as relatively under control in the United States, at levels that would allow the Federal Reserve to cut interest rates in 2026. This led to strong performance among longer-term bond funds, which are more sensitive to interest rate changes than shorter-term bond funds. Meanwhile, emerging-market funds had benefited from the US dollar’s significant decline in 2025.
But key prewar trends have reversed. As inflation concerns built on surging energy prices, rate cut expectations were dashed, replaced in the bond market by small odds of a rate hike this year. At the same time, the US dollar strengthened.
Here’s a look at performance among categories that have seen swings in relative performance since the start of the war.
Emerging-Market Bond Funds
In the 12 months leading up to Feb. 27, emerging-market local-currency funds returned 19.6%, the most of any category. In second place were US-dollar-denominated emerging-market bond funds, which gained 12.6%. Among the trends fueling the performance of these bonds were expectations of Fed rate cuts and a weakening US dollar, which lifted the value of emerging-market currencies.
During the 12 months before the war began, the best-performing of the 1,475 US-domiciled bond funds with more than $100 million in assets was the $1.6 billion Eaton Vance Emerging Markets Local Income Fund EEIIX, which returned 27.6%. Overall, seven of the 10 best-performing US-domiciled bond funds also came from emerging-market categories.
It’s a different story since the war started at the end of February. The Eaton Vance Emerging Markets Local Income fund has lost 6.6%—the third-worst loss of any US-domiciled bond fund—while its category peers averaged a 2.9% decline—the worst of any bond fund category.
Global Bond Funds
Global bond funds, which invest around the world and typically have 40% or more of their assets in non-US bonds, also performed well before the Iran war. The best performer was the $3 billion Templeton Global Bond Fund FBNRX, which gained 16.8% in the year before the war. Its peers averaged a 9.4% return, the third-highest of any category.
Funds in the global bond fund category averaged a 1.7% drop since the war started. The worst-performing fund in the category has been the $1.6 billion Invesco International Bond Fund OIBIX, which is down 4.2%.
Long-Term Bond Funds
In the 12 months before the war, longer-term bond funds outperformed short-term funds, benefiting from falling rates. The yield on the benchmark 10-year Treasury note dropped to 3.97% on the eve of the war from 4.29% a year earlier. This helped bond funds with longer durations—a metric of how sensitive a bond is to interest rate changes. As rates fall, bond prices rise, and vice versa. Funds in the long-term bond category returned an average of 6.4% during that year, compared with 5.6% for short-term bond funds and 4.6% for ultrashort bond funds.
Since the start of the war, bond yields have risen on worsening inflation expectations, with the 10-year US Treasury yield climbing to 4.25%. Against this backdrop, funds in the long government category averaged a 3.3% decline, worse than any category besides local-currency emerging-market funds. The $491 million PIMCO Extended Duration Fund PEDIX had the largest loss of any US-based bond fund outside the global or emerging markets categories, falling 6%.
Short-Term Bond Funds
Rising rates have meant that the bond funds with the shortest duration have been hit less hard. The best-performing bond fund since the war began is the $353 million Victory Floating Rate Fund RSFYX, which has gained 3.2%. It’s a bank loan fund, meaning the bonds it holds adjust along with interest rates. Funds in the bank loan category returned an average of 0.8% since the start of the war, the highest of any category.