Funds With Flexibility

Go-anywhere bond fund managers can pick and choose from a complete menu of income investments.

- Ryan Ermey

With the broad band market down 2% so far this year, it’s easy to see the appeal of a fund that can invest in the corners of the market that are working. That’s where so-called unconstrained bond funds and their cousins, multisector bond funds, can help.

As the name implies, unconstrained funds (classified as “nontraditional” funds by Morningstar) can invest in a variety of fixed-income assets, from investment-grade corporate debt to junk bonds issued by firms with below-average credit ratings to emerging-market IOUs. They can hold outsize slugs of the fund’s assets in the bond sectors they prefer, or they can sell short (a bet that prices will fall) the securities they see headed south. Some of the funds can even hold stocks. Multisector bond funds are nearly as flexible, but some have limits—albeit broad—on how much may be invested in a given sector.

But the increased freedom comes with some extra risk, especially when big wagers go wrong. In one striking example, Janus Henderson Global Unconstrained Bond, the fund run by erstwhile “bond king” Bill Gross, lost 3% in a single day in May, caught off balance by a bet that German bonds would fall in price relative to Italian bonds (the market moved the other way). There are other caveats. Many of the funds in the two categories don’t have long track records, and expense ratios can be pricey.

We think the funds below represent the best combination of flexibility and moderate risk. They come with reasonable expenses and have shown they can withstand periods of market volatility. All are geared to prosper as rates rise, and most important, they are run by managers capable of taking full advantage of their freer rein. Returns and other data are through June 15.