In a world of low yields, market swings and uncertainty, it’s not surprising that there isn’t much love for bond funds these days. Just about every type of bond fund class has seen record outflows in the past couple of years as investors look to minimize their risk and find something that offers a decent return.
Recently, there has been a lot of movement into so-called unconstrained bond funds. These funds take a flexible approach and use a variety of strategies to seek return wherever it may be. Most unconstrained funds operate on their own principles, investing in what they want and how they want changing paths depending on the market. One year that could be hiding in the safety of U.S Treasuries, the other it could entail use of hedging strategies and a heavy stake in emerging markets. Although a solid unconstrained fund could prove to be a valuable component of a diversified portfolio, experts advise to tread carefully and understand what you’re investing in.
Aaron Izenstark, managing director and co-portfolio manager at the IRON Strategic Income Fund, says there isn’t anything necessarily new about the trend of moving around the bond market for opportunity. Izenstark often thinks of the IRON Strategic Income Fund as a “credit opportunity” fund, because they use both long and short positions to meet their objectives.
Eric Jacobson, Morningstar senior fixed-income analyst, says there isn’t a lot of history with nontraditional bond strategies. Only a small group of these funds were around during the 2008 crisis and only about half of the current group was around during the 2011 European crisis and U.S. Treasury bond flight to quality.
These unconstrained funds can also be rather expensive. Jacobson says expense ratios in nontraditional bond funds are nearly double that of a typical intermediate-term bond fund. Retail investors are paying an average of 1.03% for nontraditional bond A shares, while expense ratios in bond funds as a whole typically run 0.6% or less.