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By Josh Charney, CFA | 10-08-2014 10:00 AM

Bond Funds That Hedge Against Rising Rates

Nontraditional bond funds may prove more resilient when rates rise, but watch out for credit risk.

Josh Charney: The non-traditional-bond category has garnered a lot of attention recently. In 2013, for example, the category exhibited an organic growth rate of 78%, while the funds now stand at $154 billion in assets. There are two primary reasons why investors are flocking to these funds.

The first is that many of them offer an ability to hedge duration, which basically means they stand to lose less when interest rates rise. The second reason is the general nature that many of these funds are unconstrained, meaning that more of these funds have more sources of income.

There are four major players in this space. They are JPMorgan Strategic Income Opportunities (JSOAX), Goldman Sachs Strategic Income (GSZAX), BlackRock Strategic Income Opportunities (BASIX), and PIMCO Unconstrained Bond (PUBAX), which are all rated Neutral. There are also two funds in this space that Morningstar rates positively, which are FPA New Income (FPNIX), which is rated Silver, and Driehaus Active Income (LCMAX), which rated Bronze.

Finally, a word of caution: Investors should note that many of these funds invest to a high extent in high-yield bonds, which could mean that they take on more credit risk. Also, just because these funds hedge against duration doesn't necessarily mean that the manager is going to make the right call should interest rates rise.

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