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The Search for Income: Go-Anywhere Bond Funds

A new crop of CEFs have flexible income mandates, giving managers freedom to roam. 

Cara Esser, 02/15/2013

The idea of a "set it and forget it" portfolio is appealing to many investors, but, in reality, this rarely works. Investors must check in with their holdings at least annually to gauge performance, reassess investment objectives, and consider whether the current holdings or allocations will meet these goals. Determining whether a specific holding or allocation will continue to meet an investor's goal is difficult and requires an assessment of the current and future market environment. Most individual investors don't have the time or wherewithal to take on these important questions. Even deciding how much to allocate to each asset class and when to change the allocations are common and difficult issues to tackle. Unfortunately, we won't tackle that issue here, but there are some interesting new closed-end funds, or CEFs, emerging that may eliminate at least one headache.

When it comes to allocating assets to fixed-income securities, it may be tempting to dump the full allocation to a single fund or strategy, but this is misguided. There are varying sectors underneath the fixed-income umbrella, each with its own risk and reward profiles. Yield-hungry investors might be lured by the high payouts of junk (or high-yield) bonds while risk-averse investors might lean toward U.S. Treasuries. This kind of thinking isn't wrong, but it can be detrimental to future income and investment goals. Individual investors, in general, have woefully poor market-timing skills, and the yield-hungry investor is likely to jump into the high-yield market at exactly the wrong time. We saw this last year as a few high-paying CEFs were pushed to unbelievably high premiums by investors blinded by impressive distribution rates. But playing it too safe by hoarding Treasuries may mean losing money on an inflation-adjusted basis.

So, what's an investor to do? One answer is to leave these allocation decisions to the professionals. Last year, five "go-anywhere" fixed-income CEFs were launched, and PIMCO launched its second in January of this year (PIMCO Dynamic Credit Income PCI). During the past six months, nearly half a dozen funds with flexible fixed-income strategies have filed with the SEC, including funds from Eaton Vance, Western Asset, BlackRock, and DoubleLine. Of course, just because a fund has filed with the SEC in no way guarantees that it will launch, but this is certainly a trend many firms are trying to capitalize on.

Evaluating "Go-Anywhere" Funds
Evaluating these types of funds can be difficult, especially in the context of the newly launched CEFs. While there are a number of multistrategy CEFs, those funds generally devote a pre-specified allocation to various sectors, say one third each to high-yield, senior loans, and mortgage bonds. In practice, weightings may vary slightly, but the overall allocations remain relatively stable over the long term. Two of the largest multistrategy CEFs are Calamos Convertible & High Income CHY and Calamos Convertible Opportunities & Income CHI. Both have earned Morningstar Analyst Ratings of Bronze.

On the other hand, many of these newly launched and perhaps soon-to-be-launched funds use the words "flexible" and "open mandate" to describe their strategies. These funds may have no stated benchmark or use a broad index like the Barclays Capital Aggregate Bond Index. Managers might be evaluated and paid based on absolute total returns, as opposed to returns relative to a peer group or specific benchmark. This can make any analysis of returns challenging.

To gauge how a manager is likely to react in different markets, investors can sift through old portfolios or, in the case of a new fund, look at holdings and allocations from other funds the manager runs. (In the case of three CEFs, there are similarly invested open-end mutual funds with longer track records that can be used as a guide. The discussion below Table 1 includes the funds' tickers.) Some managers (particularly PIMCO's Bill Gross and DoubleLine's Jeffrey Gundlach) have outsize personalities and often speak with the media about their ideas on the market. Investors can catch glimpses of potential portfolio action through these outlets as well. At the end of the day, though, investors are putting their faith in the manager and his or her team to correctly and quickly identify risks and opportunities. The ability for a manager to be nimble is imperative, especially if he is taking a concentrated bet, which we've seen in a number of funds launched last year.

The table above lists four of the CEFs launched last year that have at least one month of portfolio data available. The iShares Core Total U.S. Bond Market ETF AGG is shown to provide broad context for holdings. Two of the funds, Legg Mason BW Global Income Opportunity BWG and Virtus Global Multi-Sector Income VGI, have global mandates, investing in various sectors across developed- and emerging-world markets. The remaining funds do not specifically outline a global or domestic strategy and seemingly have the ability to invest globally should managers see fit. While VGI has concentrated its holdings in lower-quality corporate bonds, BWG has focused on government bonds, mostly from developing markets, notably Brazil, Mexico, and South Africa. It also has a sizable allocation to collateralized mortgage bonds and U.S. corporate bonds. Silver-rated open-end fund, Legg Mason BW Global Opportunities Bond GOBAX, is run by the same team that manages BWG. The mutual fund's current holdings are similarly allocated to government bonds, with a sizable share investing in Mexico.

Cara Esser is a closed-end fund analyst at Morningstar.

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