A flexible fund that can work its way around a market that values at over $56 trillion. Sounds amazing doesn’t it? The rapidly-growing unconstrained bond fund is attracting a great deal of investors, but don’t treat it as a universal replacement for traditional bond funds.
The math that is involved with figuring out bonds can be tricky. If you toss in other factors, such as the flexibility emerging market debt, high yield and investment grade and derivative strategies, it looses a lot of its glamour. That’s because unlike conventional bond funds, which are pretty-much straightforward in risks, unconstrained bond funds are trying to find a return in a market that simply does not have much to offer.
For the majority of investors, they are not going to be aware of the risks involved with unconstrained bond funds. There are many complicated risks involved that are hiding in the shadows when we talk about unconstrained bond funds. Managers of unconstrained bond funds have free run to bond pick and market time; unlike regular funds.
Unconstrained bond funds have enjoyed an impressive five-year run due to the Fed’s monetary policy that created a financial “high” that could possibly continue if interest rates do in fact raise later this year. If the Federal Reserve does raise the rates it will have consequences on traditional bond funds and will further increase the popularity of unconstrained bond funds since they do help the investor to navigate through higher interest rates.
Even though unconstrained bond funds seem to do well in nearly any type of market environment, they should not completely replace traditional bond funds in your portfolio. Yes, higher rates to have adverse effects on traditional bond funds, but unconstrained bond funds are basically a mix of different strategies. Some of those strategies involve trying to simply guess on rates via negative duration, which is a strategy that does not very well.