3 Funds That Go Their Own Way

Since the start of the year, various subsectors of the fixed-income markets have ridden waves of unexpected news. Oil prices dipped below $30 a barrel, stressing many high-yield energy companies. Yields across the broad investment-grade fixed-income landscape have continued to tumble to record low levels. As of July 26, 2016, the 10-year U.S. Treasury sat at a modest 1.56%, while the German and Japanese 10-year equivalents offered negative yields. Negative yields have pushed yield-seeking investors around the globe into new territory. For example, some investors outside of the United States have even scooped up U.S. municipal bonds, viewed as a high-quality, positive-yielding substitute for negative-yielding government bonds elsewhere, even though they can't take advantage of the tax benefits.

While the current environment continues to challenge conventional bond-investing wisdom, the following three young fixed-income funds from our Morningstar Prospects list are noteworthy because they approach their markets in unconventional ways. In addition, each of these funds has compelling fundamental attributes--whether experienced management teams, strong investor-focused parent firms, or attractive fee profiles--that make them worth a look.

Artisan High Income ARTFX

Lead manager Bryan Krug has a unique approach and an impressive record of applying it. While many high-yield managers favor companies with hard assets that can support bond values if a company's financial condition deteriorates, Krug tends to also look for asset-light firms owning intellectual property that helps generate strong cash flows, such as software companies and insurance brokers. Krug favors lower-rated bonds and makes heavy use of second-lien bank loans, which many industry observers have suggested are much less liquid than bonds or first-lien bank loans. That approach courts plenty of risk, but Krug has executed it well over time. When he was the lead manager of

Dodge & Cox Global Bond DODLX

Dodge & Cox Global Bond follows a process that's similar process to its U.S.-focused cousin

Vanguard Tax-Exempt Bond Index VTEAX In August 2015, Vanguard launched the market's first municipal-bond index mutual fund, Vanguard Tax-Exempt Bond Index, and its exchange-traded share class, Vanguard Tax-Exempt Bond ETF VTEB. Vanguard is synonymous with indexing and is also the largest manager of active open-end municipal-bond funds, so it is well-prepared to execute a muni index strategy. Run by manager Adam Ferguson, the fund tracks the S&P National AMT-Free Municipal Bond Index, a broad, market-value-weighted index designed to mirror the performance of the investment-grade muni-bond market. By design, this benchmark focuses on the muni market's most-liquid issuers by setting minimum credit-rating and lot-size requirements. For example, to be included in the index, an issue must have a minimum credit rating of BBB- and a minimum par amount outstanding of $25 million, among other requirements. The S&P National AMT-Free Municipal Bond Index specifically excludes certain types of less-liquid securities, such as derivative securities, housing bonds, and tobacco bonds.

The fund has continued to garner assets since its launch yet is still moderately sized at around $400 million as of mid-July 2016. This is noteworthy, as the size of an index fund can affect how well it replicates the characteristics of its target benchmark. A larger size generally lends itself to broader sampling and thus (in theory) more-efficient index tracking. With that, the fund has shown very modest tracking error to date and has therefore performed in line with its benchmark, despite its relatively smaller asset base. In addition, the fund's low 0.12% fee compares well with its peers in both the muni-national long open-end and exchange-traded fund categories.

Sumit Desai, Cara Esser, and Elizabeth Foos and contributed to this report.

Morningstar Prospects highlights promising managers that Morningstar Manager Research analysts currently do not cover but may cover in the future. The full list and publication are available to subscribers of Morningstar Direct.