(The author is a Reuters columnist and the opinions expressed
are his own. For more from John Wasik see link.reuters.com/syk97s)
By John Wasik
CHICAGO, March 31 As the financial markets await
more signals on the Federal Reserve's interest-rate policy next
year, which may push rates higher in early 2015, it wouldn't
hurt to take a close look at alternative bond funds.
Unlike conventional bond index funds, which may hold static
portfolios, "unconstrained" or "hedged" funds are able to be
nimble when rates rise. Although they may not totally avoid
losses that could come with rising rates, they could avoid some
of the volatility. Ten bond dealers out of 17 polled by Reuters
see the Fed raising rates in the second half of 2015, with
another four saying increases would not start until 2016.
Last Friday, Charles Evans, president of the Federal Reserve
Bank of Chicago, said eventual rate hikes would likely follow a
"shallower path of increases."
One way of avoiding losses in your income portfolio is to
shorten maturities of the single bonds you're buying or shorten
durations in the bond funds you own. Duration is a measure of
interest-rate risk. If your fund has a duration of 3, you could
lose 3 percent if rates climb one percentage point.
Another worthy consideration are bond funds that hedge
interest-rate risk or have the ability to shift their portfolios
into less-volatile bonds.
For example, the ProShares High Yield-Interest Rate Hedged
ETF tracks an index investing in high-yield corporate
bonds, but holds short positions in U.S. Treasury securities.
The strategy is that a rise in rates - hurting the junk bonds -
will be offset by the short Treasuries.
The ProShares fund, charging 0.5 percent for annual
expenses, is up nearly 1 percent year to date through March 28,
compared with nearly 2 percent for the Barclays U.S. Aggregate
bond total return index, a proxy for the U.S. bond market.
What's unique about the ProShares fund is that it targets a
zero duration, which means it's designed not to lose value if
Another approach is an "unconstrained" fund that has
flexibility to buy a variety of bonds, depending upon market
conditions. The AllianceBernstein Unconstrained Bond Fund I
(AGLIX), with an expense ratio of 0.6 percent annually,
concentrates on preservation of capital.
Last year, when the overall bond market, as measured by the
Barclays index, dipped 2 percent, the AllianceBernstein fund
rose 0.48 percent. It's up 1.2 percent year to date through
Although the unconstrained or hedged approach makes sense
for some investors, not every fund with that strategy will do
well, since it often involves an active manager gauging where
the market is headed.
The Pimco Unconstrained Bond D (PUBDX), not only
underperformed its benchmark in recent years, but it's also
expensive for a bond fund, charging 1.3 percent in annual
expenses. An all-purpose exchange-traded fund like the iShares
Core Total US Bond Market ETF, in comparison, charges
0.16 percent annually.
The Pimco fund lost 2.6 percent last year and trails the
Barclays average in annualized returns over the past three years
by nearly 2 percentage points, which is a large gap for income
funds. (Disclosure: I hold the iShares fund in my 401(k).)
You may be better off in a short- or ultra-short-term bond
fund, which keeps maturities and durations low, which means
they're not that volatile.
The iShares Core Short-Term US Bond fund, has a
duration of around 2. It made money last year, gaining 0.62
percent and is up 0.23 percent year to date through March 28. It
costs 0.12 percent in annual expenses. A similar fund is the
SPDR Barclays Capital Short-Term Bond Fund. It rose 1.3
percent last year and is up 0.4 percent year to date through
March 28. It also costs 0.12 percent to own.
Keep in mind that with any bond fund that provides some
insulation to interest-rate risk, there's a trade-off. With
shorter-maturity bond funds, you'll see a lower yield than the
broader bond market. Hedged funds are more expensive to own,
which eats into your yield.
How you use these funds depends upon how you manage your
income portfolio. Short-term and hedged products may be best for
cash management: Money that you will need for paying taxes,
coming homeowner expenses and other expenditures you expect
within the next year.
A more diversified approach - particularly for those who are
in or near retirement - is needed long-term. You'll need a mix
of floating-rate or senior loan exchange-traded funds,
municipal/government/emerging market and corporate bonds of
varying maturities. If you own single bonds, hold them to
maturity or buy bonds with higher yields as they come on the
If you construct an income portfolio with broad holdings
that is diversified, it will allow you to pay less attention to
what's happening with the Federal Reserve. Having a customized
plan in place will help prepare you for inevitable interest rate
hikes - even if they are telegraphed well in advance.
(Follow us @ReutersMoney or here;
Editing by Beth Pinsker and Dan Grebler)