Unconstrained Bond Funds Enjoy Surging Popularity

The investing world was indeed surprised when bond investor extraordinaire William Hunt "Bill" Gross left Pacific Investment Management Company (:PIMCO) to join Janus Capital Group (JNS). What followed the surprise was a series of speculations about and certain events related to why Gross splitting from his co-founded PIMCO after a four-decade stint. Reports suggested Gross’ exit was a result of mounting tensions in PIMCO that was becoming a tough task for Gross. Gross was perhaps on the verge of getting sacked.

However, his shift seems logical for Janus. Here, he is in charge of managing Janus Unconstrained Bond A (JUCAX), which had $12.9 million worth of assets under management at the end of August as compared to Gross’ flagship PIMCO Total Return Fund’s assets under management is about $222 billion. Unconstrained bond funds require active management. These funds are linked to no particular index and demands efficient and active management expertise to generate profits.

Thus, Janus made a master move by roping in the “bond king”. In fact, the website of the particular fund notes “Bill Gross is one of the world’s foremost thought leaders on fixed income. His unconstrained, macro style of investing offers investors an exceptional approach to navigating today’s markets, which are deeply affected by central banks and macroeconomics.” (Read: Janus Funds to Gain as Bill Gross Takes Office)

The move of Gross is much like investors worldwide shifting their assets to unconstrained bond funds. Unlike major bond funds that recorded significant outflows last year, unconstrained bond funds had attracted money in 2013. The increasing popularity is further evident from the fact that BlackRock, Inc. (BLK) and The Goldman Sachs Group, Inc. (GS) have witnessed their unconstrained bond funds doubling in size in one year.

The low-interest environment has been pushing unconstrained bond funds’ popularity. The interest rate risk is often mitigated by fixed income strategies, and unconstrained bond funds capture this fixed income return strategy pretty well.

Understanding Unconstrained Bond Funds

These funds are often called the “go anywhere” funds as they are not linked to any specific index and as CNBC puts it they are a “bigger part of the investing landscape”. These funds invest in bond, interest rate and even in currencies and related securities. Investments in these instruments are made irrespective of their location. Also, it is much like a hedge fund that seeks to tap opportunities by investing in macro events.

To get a more detailed view of what unconstrained funds do, let’s look at the funds’ investment strategies of the PIMCO and Janus unconstrained funds (according to their fund prospectus)
PIMCO Unconstrained Bond Fund

“The Fund seeks to achieve its investment objective by investing under normal circumstances at least 80% of its assets in a diversified portfolio of Fixed Income Instruments of varying maturities...The Fund will not be constrained by management against an index. The average portfolio duration of this Fund will normally vary from (negative) 3 years to positive 8 years based on Pacific Investment Management Company LLC's ("PIMCO") forecast for interest rates. Duration is a measure used to determine the sensitivity of a security's price to changes in interest rates. The longer a security's duration, the more sensitive it will be to changes in interest rates.”

The fund is offered under various asset classes. Among them it has Institutional – PFIUX, Class A – PUBAX, Class C – PUBCX.

However, all these funds currently carry a Zacks Mutual Fund Rank #5 (Strong Sell).

Read: Mutual Fund Classes: Learning A, B, C and I

Janus Global Unconstrained Bond

“As an “unconstrained” fund, the Fund has the flexibility to invest across all fixed-income asset classes, and is not managed to be compared to any specific index. The Fund has significant latitude to pursue opportunities across the fixed-income spectrum to create a diversified portfolio of varying maturities, including moving between sectors or across credit risk, and may have long, short, or negative duration. The Fund may invest without limit in high-yield/high-risk bonds, also known as “junk” bonds”.

What Makes Unconstrained Bond Funds Popular?

A major reason behind the surging popularity of this category is the low interest rate environment. Low interest rates often lead fixed income seeking investors to buy corporate debts or emerging market sovereign bonds. Unconstrained bonds offer both these. Also, the risk of interest rate rising further is mitigated in these bonds. When rates rise, index-linked holdings may witness lower bond prices. However, as unconstrained bond funds are not restricted to any index, the funds do not need to hold the same instruments as the underlying index and can rearrange holdings. Moreover, these funds short and hold negative duration securities. Maintaining shorter duration gives unconstrained bonds an advantage during rising rates.

Unconstrained Bond Funds See Significant Inflow

According to Lipper, unconstrained bond funds attracted $45.7 billion in 2013. This is in contrary to core bond funds losing $33.4 billion, while U.S. Treasury funds and U.S. high-yield funds saw outflows of $31 billion and $6.5 billion, respectively. Also this year, unconstrained bond funds have pulled in $32.7 billion till Sep 30 and core funds attracted $37.3 billion. However, high-yield funds and treasury funds are still witnessing outflows.

Meanwhile, Morningstar notes that the biggest U.S. unconstrained bond fund, Goldman Sachs Strategic Income Fund, lured more than $17 billion in the past one year. The second biggest unconstrained bond fund, BlackRock's Strategic Income Opportunities Fund, witnessed $11 billion worth of outflow in 12 months.

However, Goldman Sachs Strategic Income A (GSZAX) currently holds a Zacks Mutual Fund Rank #5 and BlackRock Strategic Income Opportunities Portfolio Investor A (BASIX) has a Zacks Mutual Fund Rank #4 (Sell).

Nonetheless, their 3-year annualized returns are at par with a Morningstar senior research analyst notes, i.e., the biggest non-traditional bond funds have positive returns over the 3-year annualized periods. While GSZAX returned 6%, BASIX has returned 5%.

Among other popular names, JPMorgan Strategic Income Opportunities A (JSOAX) has returned 3.4% in three years. However, this fund too carries a Strong Sell rating.

2 Funds to Buy Now

Here we will suggest 2 funds for investors looking to capture gains from the broader Diversified Bonds Fund segment. These funds carry a Zacks Mutual Fund Rank #1 (Strong Buy). Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performances, but the likely future success of the fund.

These funds also have relatively low expense ratios. These funds have a minimum net asset of $50 million.

PIMCO Income A (PONAX) invests a minimum of 65% in a multi-sector basket of Fixed Income Instruments that have different maturities including options, forwards and swaps. Also, a maximum of 50% is invested in below investment grade high-yield securities. However, these securities must have at least Caa rating by Moody’s or equivalent rating agencies.

PONAX currently carries a Zacks Mutual Fund Rank #1 (Strong Buy) and has returned 7.4% year to date. Also, the fund has 3 and 5-year annualized returns of 11.5% and 12.1%, respectively.

The fund has an annual expense ratio of 0.85% as compared to category average of 1.08%. The fund carries a max front end sales load of 3.75% as compared to category average of 4.15%.

T. Rowe Price Strategic Income (PRSNX) seeks high income and growth of capital by investing in a mix of holdings. It invests a major portion of its assets in income generating securities. It may invest a maximum of half of its assets in foreign debt instruments. It may also invest a maximum of 65% of its assets in securities that are rated below investment grade.

PRSNX currently carries a Zacks Mutual Fund Rank #1 (Strong Buy) and has returned 5.8% year to date. Also, the fund has 3 and 5-year annualized returns of 5.7% and 6.1%, respectively.

The fund has an annual expense ratio of 0.66% as compared to category average of 1.05%. The fund carries no sales load.

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Read the analyst report on PONAX

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Read the analyst report on GSZAX

Read the analyst report on BASIX

Read the analyst report on JSOAX

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