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By Christine Benz and Eric Jacobson | 09-27-2012 01:00 PM

Your Nontraditional Bond Fund Might Surprise You

And not in the good way, as Morningstar's Eric Jacobson cautions that numerous portfolios in the category have proved to be more volatile and have lower returns than some might think.

Christine Benz: Hi, I'm Christine Benz for So-called nontraditional bond funds have been major asset gatherers during the past few years. Joining me to provide an update on this category is Eric Jacobson. He is a senior fund analyst with Morningstar.

Eric, thank you so much for being here.

Eric Jacobson: Hi, Christine, great to be with you.

Benz: Eric, nontraditional bond is our category for this grouping of funds, but there really are some different strategies going on. Let's talk about the unifying themes among these nontraditional bond funds.

Jacobson: Sure. Well, the unifying themes tend to be a question of interest-rate sensitivity for the most part. They didn't all start out that way, but that's kind of how they've coalesced. And for the most part that means that they generally have a very wide range within which they can manage their rate sensitivity. They generally define it by duration, and they often can go a little bit negative and very long to the positive. That gives them a tremendous range, as I just said, to go in. But a lot of them have been managing themselves very close to the short end of the range. Arguably [they do this] for tactical reasons. So the trick there is we don't really know how many of them might actually go a lot longer at some point because they say they have the freedom to do it. But, like I said, most of them have stayed pretty short.

Benz: Part of the value proposition, Eric, right now in particular, if people are concerned about rising interest rates down the line, the idea with some of these funds is that they might be able to navigate a little better than funds that are pegged to, say, a specific duration range?

Jacobson: That's right. They didn't all market themselves quite that way to start off with. But that is the unifying theme and the unifying marketing message frankly, at this point. They're all trying to convince investors that they're the best place to be pretty much if you fear rising interest rates.

Benz: Eric, are these funds investing mainly in domestic bonds, or they investing in foreign bonds, as well?

Jacobson: Well, several of them do have a foreign component. So, for example, PIMCO Unconstrained has at least 15% in emerging markets, which has helped it out. The Eaton Vance Global Macro Absolute Return fund is almost all non-U.S.; it has a lot of non-U.S. countries, and a lot of non-US currency. Of course, it's managed in such a way that it tries to be very, very short and low-volatility, but it tends to be mostly a foreign fund. The JPMorgan Strategic Income Opportunities [is invested] mostly in the U.S. So, they really do run the range there.

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