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By Bloomberg

Bond funds, long considered among the safest investments, are turning out to be a lot riskier than they seem.

Historically, their returns have been far less prone to sudden swings than stock funds. Not this year. In fact, those that buy long-term government and corporate debt have been more volatile relative to equity funds than at any time since the turn of the century, according to Morningstar Inc.

While markets have been buffeted by everything from the prospect of higher U.S. interest rates to the Greek debt crisis and China’s stock meltdown, one reason why returns on long-term bonds have become so unpredictable is that ultra-low yields are making them more sensitive to gains and losses. At the same time, the rise of derivatives has allowed savvy traders to make low-cost bets that can sway the market in a big way.

For ordinary Americans who have plowed $1 trillion into fixed-income funds since the financial crisis, it’s a risk they might not be willing to take. Individuals are pulling money for the first time this year, which threatens to keep bonds under pressure after their worst quarterly loss on record.

“People are taking more risk in long-term fixed income than they realize,” said Kate Warne, a St. Louis-based strategist at Edward D. Jones & Co., where advisers manage about $870 billion for individual investors. “Changing investors’ expectations about bond-market volatility is important, because it’s not on their radar screens.”

By almost any standard, the turbulence faced in 2015 by investors seeking the safety of fixed income has been remarkable.

Standard Deviation

Bonds worldwide have failed to post successive monthly gains this year, while July’s 1 percent advance followed a second-quarter loss of 2.2 percent, the deepest since at least 1996, data compiled by Bank of America Corp. show.

Based on swings in performance in the first half, investors in funds that buy long-dated debt can expect annual returns ranging from a gain of 17 percent to a loss of 23 percent about 95 percent of the time, according to Morningstar, which looked at a statistical measure called standard deviation.

For funds that only invest in long-term government bonds, the expected range is even wider, exceeding the volatility of stock funds by the most since at least 1999. Not even in 2013, the year of the bond market’s “taper tantrum,” did returns from long-term government debt funds fluctuate as wildly.

Investors can point to plenty of reasons why bonds have been volatile this year. The European Central Bank has distorted debt prices with its quantitative easing. Crises in Greece and China have rattled financial markets.

‘Inherently Volatile’

And, of course, the Federal Reserve is closer than ever to raising rates, which it has held close to zero since 2008. The next central bank policy meeting is Sept. 16-17.

“You’re starting with an inherently volatile situation, and then adding the change in monetary policy,” said Alan Gayle, the director of asset allocation at RidgeWorth Investments, which manages $42.5 billion.

Yet underlying it all is how much more perilous the bond market itself has become. Typically, bond investors are shielded from swings in prices by the steady stream of interest payments they get each year.

But because yields are so low, even small moves have the potential to wipe out returns, especially if you’re invested in bonds that pay out over a span of a decade or more.

This year, that so-called duration hit a record high of 6.5 years for the $45 trillion of bonds tracked by Barclays Plc.

“I’m not really getting compensated for that” risk, said Thomas Atteberry, who manages the $5.7 billion New Income Fund for First Pacific Advisors Inc. in Los Angeles. As a result, Atteberry said his fund owns no investment-grade debt and he treats his Treasury holdings like cash.

The benchmark Treasury 10-year note yielded 2.20 percent as of 8:36 a.m. London time.

Long Mandate

It isn’t that simple for the fund managers whose mandates require them to stick to long-term debt.

In the first three months of 2015, Pacific Investment Management Co.’s $4 billion Long Duration Total Return Fund gained 3.4 percent, data compiled by Bloomberg show. Over the next three, it lost 7.1 percent. Those swings have made the volatility of its returns 79 percent greater than rival funds in the industry, the data show.

Regardless of what happens in the near term, the growing number of retirees and pension funds seeking steady, low-risk income will underpin debt demand for years to come.

Americans are getting older and getting “more focused on streams of income,” said Kevin Giddis, the Memphis, Tennessee- based head of fixed income at Raymond James & Associates.

Big Worry

Still, the big worry is that a string of bond-fund losses will set off a wave of withdrawals and upend demand in debt markets. In 2013, when then-Fed Chairman Ben S. Bernanke sparked a selloff by suggesting the central bank could reduce its bond buying, taxable bond funds lost $13 billion from redemptions alone, according to Investment Company Institute.

That was the most since 2000 and coincided with just the second annual loss on record for bonds globally, index data compiled by Bank of America show.

Some individuals aren’t waiting around to see what happens this time. After sending a net $50 billion into bond funds in the first half, investors have withdrawn $3.5 billion in the first three weeks of July, ICI data show.

The rise of fixed-income derivatives, which let professionals make large speculative bets with small amounts of money, is adding another risk to owning bonds.

At the end of June, there were $40 trillion of derivatives contracts listed with the CME Group Inc. That’s more than triple the size of the $12.7 trillion Treasury market. The built-in leverage can boost performance, but it can also worsen market stress if traders sitting on losses are forced to dump securities to put up more cash.

“In an environment where investors are reaching for yield, a lot of fund managers are doing so with leverage,” Edward Jones’s Warne said. “That’s one of the things we’re always concerned about.”