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Finding Flexible Bond Funds That Earn Their Keep

We screen for fixed-income offerings that have made the most of a flexible investment strategy.

With the looming threat of inflation and rising rates hanging over fixed income, bond funds that have more flexibility to add value while avoiding trouble spots are quickly gaining investor attention. The major distinction of these funds--typically found in the multisector bond category--is that they have the latitude to invest across a wider range of fixed-income securities, potentially including domestic and foreign issues, and bonds from across the quality and maturity spectrum.

For that reason, such funds' composition might change from one quarter to the next, making them less predictable than the standard core fund. This might be especially true of the so-called unconstrained multisector bond funds, a name that is typically used to describe portfolios that can invest both long and short in the bonds and derivatives of nearly any fixed-income sector and have wide limits on their weightings and management of interest-rate sensitivity.

When any fund offers management more latitude, it's important for investors to make sure they're comfortable with the manager's skill level and experience and to understand the actual parameters the fund is operating within (just how far afield can it go?). In addition, investors seeking more predictable portfolios will likely want to keep such funds as supporting (versus core) players, given their changing portfolio profiles.  

This week we turned to our  Premium Fund Screener to filter through Morningstar's multisector bond category for some offerings worthy of further investigation. We screened for open, noninstitutional funds under Morningstar coverage with below-category-average price tags, Morningstar Ratings for funds of 3 or better, and managers with at least five years of tenure. Below, we highlight three names that the screen revealed. Premium Members can  click here to replicate the screen and get our analysts' complete take on these offerings by reading the associated Analyst Reports.

 Loomis Sayles Strategic Income (NEFZX)
Expenses: 0.96 | Load: 4.50
Veteran lead manager Dan Fuss and comanagers Kathleen Gaffney, Matt Eagen, and Elaine Stokes have proved their stripes as former Fixed-Income Manager of the Year award winners. This fund has a standout long-term track record ranking in the top 5% of its category for the trailing-10-year period. Looking forward, the management team has taken steps to prepare for the possibility of rising rates. In his mid-May Analyst Report, Morningstar's Michael Herbst noted that 27% of the fund's assets had lately been parked in high-yield corporate debt, which tends to be less sensitive to rising rates. And though the portfolio doesn't limit itself to any niche pockets of the market, its sizable stakes in mid- to lower-quality corporate bonds, as well as frequent and significant wagers in convertibles, emerging-markets bonds, and foreign currency exposures, court a fair amount of currency and credit risk. Indeed, the fund has not been immune to short-term bumps, but as Herbst notes: "Investors who are able and willing to ride out this fund's inevitable rough patches stand the best chance of benefiting from its merits."

 Osterweis Strategic Income (OSTIX)
Expenses: 0.96 | Load: None
Managers Carl Kaufman and Simon Lee don't pay attention to benchmarks and invest mainly in a range of corporate securities, including straight bonds, convertibles, and floating-rate loans. Management focuses on lower-quality companies that are experiencing temporary struggles, but they target shorter-term debt, meaning that the fund takes on more credit risk than interest-rate risk. They offset this risk by preferring names that have the cash flow to meet their near- to intermediate-term obligations. A combination of delivering respectable yields and attractive returns coupled with a risk-conscious approach has appealed to investors. The fund doubled its asset size from 2009 to 2010. Analyst Dan Culloton says the fund isn't too big to succeed yet (asset growth is less of an issue in the fixed-income market than the equity market), but investors should monitor how management handles the growing asset base. For those who are familiar with the fund's unique strategy, this offering is a noteworthy contender as a supporting player.

 Pioneer Strategic Income (PSRAX)
Expenses: 1.10 | Load: 4.50
Long-time manager Kenneth Taubes adds value by exploiting the flexibility in the fund's mandate and rotating among domestic investment-grade bonds, high-yield debt, high-quality international securities, and emerging-markets bonds. Investors are definitely getting active management here, but with that comes risk. For instance, at the beginning of the year, the fund's combined bank-loan, high-yield, and emerging-markets exposure was more than half of assets. And though such bold moves have their share of risks, Taubes' prior moves instill confidence in his active management. For example, the fund was able to sidestep the 2008 downturn by ramping up on U.S. Treasuries while de-emphasizing low-quality debt and financials exposure. All in all, investors who are aware of its risk will find a solid choice for a supporting player in this offering.

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