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Are Nontraditional Bond Funds Living Up to Their Promise?

The answer depends on which promise you heard.

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The nontraditional bond category is dominated by funds that hope to produce absolute returns regardless of what's going on in the conventional bond market. By and large, that promise has been a response to fears over the potential for rising interest rates. Even though inflation has been tame over the last couple of years, Treasury bond yields are so low (in large part thanks to the actions of the United States Federal Reserve) that many investors believe that a large and sustained reversal of that trend is inevitable.

The good news for investors most fearful of rising yields is that this nascent category of funds has generally proven itself capable of putting up a good defense. That's not entirely surprising given that most funds in the category have tended to report durations (a measure of interest-rate sensitivity) close to zero, or in some cases even negative. Portfolio metrics and investment outcomes don't always match up, though, so it's reassuring that the group responded well during early August 2012, when Treasury bond yields spiked. The 10-year Treasury, for example, saw its yield go from 1.56% on Aug. 1 to 1.8% on Aug. 21, triggering a 2% loss inside of roughly three weeks. That's an arguably modest amount over a short period, but it's enough of a move upon which to judge how nontraditional bond funds have behaved. The results are encouraging. There are 43 distinct portfolios in the category, and the median fund in the group eked out a 0.4% gain at the same time the Treasury market was losing money. The largest funds in the group performed consistently with that average, though  PIMCO Unconstrained Bond (PUBAX) did log a small loss.

Eric Jacobson does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.