The advantages of a broader investment universe
Navigating this environment suggests investors consider less traditional approaches. One potential solution is to incorporate unconstrained bond funds. This is because, unconstrained funds offer the potential to mitigate some of the challenges enumerated above.
As their name implies, unconstrained funds typically contain a more heterogeneous mix of bonds than traditional bond funds heavily weighted to Treasuries. They often include instruments such as high yield, emerging market debt and other more esoteric instruments that tend to be missing from traditional bond funds. Many unconstrained bond funds also own some equity. This broader investment universe allows managers greater latitude and flexibility to search for yield, manage risk and tweak correlations, as they adopt different exposures and tactical stances.
Market Realist: Unconstrained bond funds are well diversified
Unconstrained bond funds don’t track any particular index, but they are actively managed. These funds take advantage of the differences in the conditions across global bond markets to provide stable returns to investors.
Unconstrained funds avoid the risks they want to avoid and take on the risks that make the most sense at a particular point in time. This makes unconstrained bond funds flexible and dynamic. These funds tend to have allocations in both high yield bonds (HYG) and Treasuries (IEF). They have exposure to both credit and interest-rate risk.
The graph above shows the notional exposure of one such fund—the BlackRock Strategic Income Opportunities Investor A (BAS)IX). The fund has exposure to mortgage-backed securities, derivatives, global sovereign bonds, emerging market bonds (EMB), derivatives, high yield bonds, and equities (SPY), among others.
As you can see, the fund is quite diversified. It also has negative exposure to some securities. Unconstrained bond funds use leverage and derivatives in their portfolios, which magnifies their risk.