The unconstrained bond fund has been introduced within the bond investment community to help investors lower their investment risks, while improving their rate of return. This type of investment is a great option for investors that believe interest rates are going higher, since the fund can invest anywhere on the yield curve and is not constrained to any particular bond duration.

When interest rates increase, the lower yields on existing bonds become less attractive making traditional bond funds unattractive. An increase in rates ultimately drives the price of the bonds down and hurts a bond investor’s return. As rates increase over time, bonds can underperform and investors are at risk of having negative rates of return.

After 30 years with a declining Treasury bond yield, many within the bond industry expect rates to start a long-term rise. The introduction of the unconstrained bond fund takes away interest rate and duration risk, so fund managers can invest anywhere on the yield curve. Managers are no longer forced to invest in one particular bond. Unconstrained Bond Fund Managers can now invest in Emerging Market Bonds, Treasury Bonds, Corporate Bonds, Junk Bonds, and they can even short bonds. An unconstrained bond fund is much more flexible and can generate healthy returns for investors even during times when the bond market is underperforming.

Investors interested in investing in an Unconstrained Bond Fund now have many options available. Some of the largest equity firms now offer this type of fund within their family of funds, which include PIMCO, Blackrock, and Federated to name a few. It’s important to review a fund’s prospectus, so you can fully understand the types of bonds that can be purchased and the level of risk that accompanies the fund.

There are risks that come with unconstrained bond funds, which include:

Credit Risk. Bond fund managers are not required to invest in any one particular bond segment, so credit risk increases.

Shorter Track Records. Many funds are only a few years old, so it leaves you with some uncertainty about whether they can repeat their past performance

Higher Expenses. Unconstrained Bond Funds do carry higher fees compared to traditional bond index funds, since it is managed by professional portfolio managers.

Unconstrained Bond Fund Performance

The ultimate goal of an unconstrained bond fund is to outperform a cash-based index, which is often the LIBOR (London Inter-Bank Offer Rate). The only other similar bond fund product available to investors in a multi-sector bond fund, but these funds must follow the weightings of that particular bond benchmark. An unconstrained bond fund gives much more flexibility and ultimately lowers many types of risks that a traditional bond fund would carry.

Unconstrained Bond Fund Portfolio Management

Unconstrained bond funds have an absolute return strategy, which means to gain as much return on investment as possible given the current investment environment. An unconstrained bond fund has active portfolio managers determining the best moves to make within the current bond market. An unconstrained bond manager can invest within any bond investment, which includes junk bonds, corporate bonds, and US Treasury bonds, and Foreign Bonds. It’s at the discretion of the portfolio manager to determine which bonds should be held within their portfolio.

Unconstrained bond fund managers also have more flexibility to focus on investments that may have a better rate of return, even if they’re only small parts of the index. This is due to the fact the Unconstrained Bond Funds are tied to a bond index, such as the Barclays US Aggregate Bond Index or the 10-Year Treasury Yield. Benchmarks tend to reward bad investment behavior, since portfolio managers are trying to invest in investments that will give them the same or better performance than the benchmark. Benchmark comparisons cause investors to think about what bonds will perform the best, instead of thinking which bonds will give them the healthiest returns for the lowest risk.

Unconstrained managers can look for bonds where they expect to soon see credit-rating upgrades or bonds from countries where debt levels are low. This can improve overall returns, while lowering the bond portfolio’s beta.

An unconstrained bond fund will usually have higher expenses, since the fund is actively managed. It’s important to do your research to make sure the fund you’re interested in purchasing is has an expense level that is at or below the industry average for non-traditional bond funds. High expenses can eat-away at an investor’s return, so the lower expense fee the fund carries the better return you will have over time.