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Does It Make Sense to Include Non-Traditional-Bond Funds in Your Portfolio?

High correlations to risky assets dent their appeal as a core-bond fund substitute.

As we discussed last week, non-traditional-bond fund portfolios have generally pursued two main themes in recent years: 1) downplaying interest-rate risk and 2) taking risk in credit-sensitive areas such as high-yield corporate and emerging-markets debt. Today, we’ll discuss the impact these preferences have had on performance and what that implies for this group’s usefulness in a broader portfolio context.

Some Success Providing Defense Against Interest-Rate Risk
Let’s start with interest-rate risk, the chief source of anxiety that drove this Morningstar Category’s explosive growth in recent years. Granted, the category has faced headwinds in that regard since its launch in 2011; Treasury yields are lower now, and there’s only one instance of the 10-year note rising by more than a percentage point in that stretch. But taking a look at the category’s performance during periods where the yield on the 10-year U.S. Treasury has risen by half a percentage point or more, as shown in the exhibit below, the group as a whole has been reasonably effective at outperforming the typical intermediate-term-bond fund in periods of rising interest rates.