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Is 2019 ripe for unconstrained bond funds?

Fixed income managers have promoted products with highly flexible mandates in response to shifting investor sentiment.
Jon Jonsson, Neuberger Berman

“Investors have to cope with small windows between pessimism and optimism, as speculation rises or recedes about the US Federal Reserve intentions on interest rates,” Neuberger Berman senior portfolio manager Jon Jonsson told FSA.

In response to rapidly shifting sentiment, fixed income asset managers have promoted products with highly flexible mandates: global unconstrained funds.

Unlike typical bond funds, these have few constraints or restrictions. The emphasis is on earning absolute returns, and investors have to depend on the discipline and prudence of the manager rather than rely on a trust deed to control risk.

“Unconstrained means different things to different people,” said Jonsson.

For example, some might seek high income with capital preservation, while other funds might extend duration or move further down the credit rating in the hope of capital growth.

Neuberger Berman’s $1bn Strategic Income fund aims to achieve a bit of both. Jonsson and his co-managers search for undervalued bonds globally and have been gradually increasing allocation to US and European high yield fixed income.

“Riskier assets should perform well, like they did in the wake of the Federal Reserve’s retreat from a hawkish stance in 2016,” said Jonsson.

Among emerging markets, he is encouraged by recent policy moves in Brazil and Mexico, and is drawn to the high yields on Russia and South Africa sovereign bonds which had slid out favour because of political risk.

Lower yields in Asia make the region less appealing, he said.

According to an Evestment report, the unconstrained approach has enticed investors, despite the elevated risks inherent in funds without mandatory restrictions.

A search for incremental yield when interest rates were low was a catalyst, and enthusiasm was maintained as investors tried to make returns (or preserve capital) when interest rates rose last year.

The report said that $145.3bn (of which $107.5 was institutional and $37.8 retail) flowed into global unconstrained fixed income funds during the past five years, taking 40% of new money during this period.

Assets under management in unconstrained fixed income funds made up $436.2bn as of mid-2018 or 20% of total global fixed income assets, according to the report.

NB Strategic Income Fund vs its benchmark index

Source: FE Analytics. Three-year cumulative performance in US dollars.

Part of the Mark Allen Group.