Investors in bond funds used to dampen the risk of rising interest rates underperformed both the “unconstrained” managers of those investments and traditional fixed-income funds during the last decade, according to a new analysis. That's because many investors got into and out of those investments at the wrong times — buying high, selling low or both.
Over the 10 years that ended May 31, investors captured just 44% of the nearly 4% return generated by managers in the nontraditional bond fund category tracked by Morningstar, which includes a popular group of unconstrained and “strategic income” funds that give managers more latitude to explore fixed-income securities across global bond markets.
That means the average investor captured a gain of just 1.75% annually over that 10-year period, which compares unfavorably not just to the return of unconstrained managers, but to the returns of investors in the popular intermediate-term bond fund category.
Investors in the latter took home nearly 2.94%, pulling in nearly 70% of the returns that category's managers generated, which were also higher than the unconstrained managers' gains. The intermediate-term fixed-income category includes funds such as the Vanguard Total Bond Market Index (VBMFX) and Pimco Total Return Fund (PTTAX) that are widely used as the core bond exposure in portfolios that financial advisers build.
“That's pretty shocking,” said Michael Herbst, the director of fixed-income manager research for North America at Morningstar, during a panel at the researcher's conference for financial advisers and fund managers in Chicago. “What that says to us is the more that we, the managers and the folks in this room, can shape reasonable expectations for how these funds will behave in various market environments will help you keep clients in these markets or keep them out of the funds if it's not something you want to take on."
TIMING IS EVERYTHING
Mr. Herbst said Morningstar data showed that the greatest flows into the funds came after years of strong performance, and the greatest outflows came after years of poor performance. Research has shown that sort of ineffective timing can erode returns.
Morningstar calculates “investor return” by estimating the return achieved by the average investor based on when investors bought and sold the fund.
Many of the funds in the category have benefited from advisers' interest in preparing for rising U.S. interest rates, which will erode bond returns. But with the exception of 2013, when markets panicked about tightening U.S. monetary policy in a “taper tantrum,” the average traditional bond fund has delivered strong returns in every year since 2009.
Michael Swell, a managing director at Goldman Sachs Asset Management and a manager of the Goldman Sachs Strategic Income Fund (GSZAX), said on Friday that manager transparency is especially critical in unconstrained funds because of the variety of strategies that exist and the fact that their holdings change often.
In a May interview, DoubleLine Capital founder
Jeffrey Gundlach said that unconstrained bond investors "will be surprised that they are actually doing worse in many of these funds" when rates rise "than they would in an index fund.” He said managers in the category often short Treasury bonds while doubling up on credit risk in securities like junk bonds, which he called a risky bet.
Some managers said the investor-return analysis may not be useful because some funds that exist today aren't 10 years old, and some have adjusted their strategies since their inception.
“It is in its infancy, in some regards, and there have been changes over time,” said Marc P. Seidner, who co-manages the Pimco Unconstrained Bond Fund (PUBAX).
