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Unconstrained bond funds: are they worth the hype?

Fixed Income Funds have been very much in the press lately, partly because of Bill Gross’s departure from PIMCO, which sparked an estimated $23.5 Billion net outflow from its Total Return Fund.  Gross is leaving to build up an unconstrained fund at Janus.  This made me think – Should MASECO be putting its clients into unconstrained bond funds?

Unconstrained bond funds represent a fast growing but still relatively small fraction of the market (about $152 Billion). The funds stray away from a traditional benchmark led approach and instead focus on trying to achieve the best positive return from Fixed-Income markets by searching for pockets of “alpha” and timing market cycles.

The idea of an “all weather” bond fund which has the flexibility to outperform in any market environment obviously has significant appeal but how many managers can actually deliver on this promise? Before making the jump into an unconstrained bond fund, investors should carefully assess the additional risks they are taking – lack of constraints can obviously cut both ways on performance, if a manager’s big bet fails to pay off. Costs are another factor to keep an eye on. With the current low yields, trading costs and fees can quickly eat up a big chunk of the returns.

MASECO sees Fixed Income as a portfolio’s safe harbour, which should be almost as safe and liquid as cash. Fixed Income’s role is to reduce the overall risk in a portfolio and provide income.

With Fixed Income, MASECO works on the premise that relative performance is largely driven by 2 dimensions: bond maturity and credit quality.  Since it is impossible to predict what will happen to interest rates in the future MASECO adopts a “variable maturity” approach, extending the maturity of the bond holdings when there is a positive yield curve and reducing the maturity when the yield curve is flat or inverted, as at present. When it comes to credit instruments, we would only consider high grade credit liquid bonds with a low transaction cost.


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