What investors need to understand about unconstrained bond funds

Active versus passive portfolio management

Unconstrained bond funds such as the Goldman Sachs Strategic Income Fund A (GSZAX) are actively managed. Their portfolios don’t follow any particular index. Their objective is to try and earn returns over and above the benchmark.

In contrast, passively managed stock (SPY) (QWLD) and bond (TLT) (BND) (IEF) funds try to match the fund portfolio to index characteristics as much as possible. Their return goal is to match the index performance.

Performance comparison

Without a benchmark, it’s difficult to compare performance. Each unconstrained fund typically follows unique strategies—since they’re actively managed—and portfolio compositions can vary significantly. Since each fund is different, you should read the fund’s prospectus and investment mandate before investing. This will ensure that the fund’s risk and return objectives match your own preferences.

Track record

Most unconstrained bond funds are new, and so have track records based on fewer than five years. And, the last five years have been somewhat different in financial markets. The Great Recession and the Fed’s unprecedented monetary stimulus, which started in 2008, may mean that historical returns will be atypical. Ensuring that the fund’s objectives match with your own is essential as we move towards a more normal monetary policy.

Fund size matters

With the majority of funds being relatively new, it’s often difficult for portfolio managers to employ scale in executing trades. This can lead to higher execution costs. This is especially relevant for unconstrained bond funds that typically have higher portfolio turnover than passively managed funds. Higher transaction costs hit you in the form of higher management fees.

Management fees

Active fund managers select securities to include in the portfolio. As a result, unconstrained bond funds have typically higher management fees compared to passively managed funds. They also typically have an initial sales charge or front-end load for certain investor categories. These charges vary depending on the fund.

Use of leverage and derivatives and magnify risks

Most unconstrained bond funds use leverage and derivatives in portfolio composition. These can result in higher portfolio volatility on the upside as well as on the downside.