5 Things to Understand About Unconstrained Bond Funds

Non-traditional bond funds such as flexible allocation and unconstrained funds aren't the cure-alls some fund companies are suggesting

Eric Jacobson 7 July, 2014 | 11:11AM
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Some non-traditional bond funds, such as flexible allocation and unconstrained funds, are certainly a lot better than others, but as a broad group they aren't the cure-alls some fund companies are suggesting. Here are five things they probably didn't mention.

1) The idea behind these funds isn't as novel as it sounds.

There's a running industry narrative that non-traditional-bond funds have sprouted up as an organic response to the (obvious) end of a multi-decade bull bond market and that the idea of an unconstrained duration strategy is a unique response to this rare market condition.

The fact is, however, that the idea of managers having the freedom to shift their funds' durations sharply and to actively anticipate movements in interest rates is an old one that characterised the bond fund environment up until the mid-1990s. The cult of equity-fund investing was still in its early development, but the foundational idea of hiring a guy like Peter Lynch to invest your money virtually however he saw fit--and among whatever stocks, regardless of size or valuation--was somewhat in vogue among bond managers, too. They couldn't shift among bond market sectors in most cases, but they usually had a lot of freedom to manage interest-rate exposure, and many investors assumed that's what they were hiring them to do in the first place.

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Eric Jacobson  is director of fixed-income research with Morningstar.