Janus, DoubleLine, and Goldman Sachs are among the latest to try their hand at strategies that aim to defy rising interest rates.
The first five months of 2014 have reminded investors once again that interest rates have a way of confounding the experts. Despite a rousing chorus predicting that interest rates would rise this year, they've done the exact opposite so far. The yield on the 10-year Treasury has fallen from 3.00% at the start of the year to 2.47% in mid-May, its lowest level since October 2013.
That hasn't stopped mutual fund companies from continuing to roll out new products designed to better navigate a rising interest-rate environment than traditional long-only bond funds. Companies have launched 10 new non-traditional-bond funds through the end of May, on pace to surpass the 20 such funds launched in 2013. Newcomers include Janus and DoubleLine, which are taking their first step into strategies that allow for a negative duration. That tool can, if used correctly, mitigate the risk of rising interest rates, which are inversely correlated to bond prices.
Indeed, interest rates have been edging back upward since dipping below 2.5%; the yield on the 10-year Treasury was back around 2.6% as of early June. But they would have to move a lot higher and a lot faster to fulfill the doom and gloom prophecy for plain-vanilla bond funds, which have little leeway to manage duration risk, that has caused so much anxiety among investors.
The lower rates, however, may be further stoking that anxiety. The lower that rates go, the more rising interest rates pose a threat, since the lower yields would provide less of a cushion for the falling bond price if rates eventually spike. Non-traditional-bond funds have received $19 billion of net inflows year to date through the end of May and $81 billion during the past 24 months.
The category covers a wide range of funds, which variously go by names such as "unconstrained," "strategic income," "opportunistic," and "flexible." The one thing they tend to have in common is delivering on the promise of less duration risk (the category norm is an average effective duration of one year, compared with a category average of 4.9 years for intermediate-term bond funds). To compensate for the lower duration, many managers have turned to another driver of bond returns, credit risk. To illustrate, the average non-traditional-bond fund has a 0.88 correlation to the high-yield bond category since 2011, whereas intermediate-term bond funds have just a 0.14 correlation.
The newly launched Janus Unconstrained Bond JUCIX and DoubleLine Flexible Income DFLEX don't seem to offer much of a different take on the space, as both have wide-ranging mandates that allow for negative duration and the ability to invest across the fixed-income spectrum. What could set them apart, however, is their notable management teams.
Gibson Smith and Darrell Watters, comanagers of Silver-rated Janus Flexible BondJFLEX and Bronze-rated Janus High-Yield JAHYX, have the reins at Janus Unconstrained Bond. The duo may be the best kept secret at Janus. Janus Flexible Bond's 6.13% 10-year annualized returns through the end of May beat 90% of peers in the intermediate-term bond category, including PIMCO Total ReturnPTTAX, thanks primarily to management's expertise in fundamental credit research, a skill that should prove beneficial in a non-traditional-bond fund.
DoubleLine Flexible Income is managed by former Morningstar Fixed-Income Manager of the Decade nominee Jeffrey Gundlach. Gundlach has been perhaps the most vocal contrarian when it comes to interest rates (on a January conference call with DoubleLine Total Return DBLTX shareholders, he correctly predicted that interest rates would fall to 2.5% in the near term), so this fund comes as a little bit of a surprise. Still, the strategy's framework falls well within Gundlach's expertise. Much like his flagship DoubleLine Total Return, the Flexible Income fund will have significant exposure to mortgage-backed securities. As of the launch date, it had approximately 21% allocated to nonagency mortgage-backed securities, 10% to commercial MBS, and 5% to agency MBS. In addition, it will have meaningful exposure to emerging-markets debt and bank loans.