The nontraditional bond fund sector continues to attract inflows and new products.
These funds had net flows of almost $25 billion through Aug. 31, according to Morningstar.
Plus, the category is getting more crowded, with 22 new entrants in 2013 and 20 or more additional arrivals projected for 2014, the research group estimates.
A key reason for the appeal of many of these funds is the fact that their flexible portfolios may offer more protection and steadier total returns in a rising interest rate environment than traditional bond funds.
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That benefit hasn’t been strenuously tested yet, though, as bond yield increases, which were widely expected for 2014, are still on hold. The 10-year Treasury, for instance, dropped to 2% in mid-October.
Some funds in this category focus on narrow niches and provide unique strategies, experts point out.
The Forward Credit Analysis Long/Short Fund (FLSIX) focuses on municipal bonds, which accounted for close to 80% of the portfolio as of Sept. 30. Short-term securities (13%) and corporate bonds (7.4%) comprise the balance, with a fraction of 1% in futures contracts.
What makes this fund unique is that it can use strategies to replicate short positions in municipal bonds. According to the fund’s materials: “A substantial portion of assets may be invested in derivatives to seek to achieve returns and for hedging.” Additionally, “The fund may engage in borrowing for investment purposes in order to increase its holdings of portfolio securities and/or to collateralize short sale positions, as well as for cash management, and short positions may equal up to 100% of the fund’s net asset value.”
The hedges are indirect due to the fund’s inability to directly short tax-exempt municipals, according to Jim O’Donnell, Forward’s chief investment officer.
Portfolio managers can work with Treasury bond futures and the Markit MCDX synthetic municipal-credit index to get around that limitation.
PIMCO is the fund’s subadvisor. However, that firm’s recent management shake-up doesn’t concern O’Donnell, because it hasn’t affected PIMCO’s municipal-bond managers, who are led by Joe Deane in New York, he says.
The fund uses two benchmarks for comparison: the Barclays U.S. Municipal Bond Index and the Barclays U.S. Corporate High Yield Bond Index.