Unconstrained bond funds generally allow portfolio managers a broader range of investment discretion than more traditional bond fund approaches that use benchmark indexes.
When bond market returns are positive, an unconstrained approach should ideally deliver positive returns that hopefully capture a material percentage of this upside. However when bond market returns are negative an unconstrained strategy should seek to limit or avoid entirely the risk exposures that produce the negative returns.
According to Sabrina Callin, and Lisa Kim, of PIMCO, the primary components of many unconstrained strategies consist of:
- The absence of a bond market benchmark
- A goal of delivering positive “absolute” returns independent of the market environment
- A focus on downside risk management
- A very broad-based, global opportunity set
- Reliance on manager’s skill as the primary driver of performance
The absence of a bond market benchmark means that unconstrained approaches have a different starting point for portfolio construction – a blank canvas so to speak rather than the structural risks embedded in the bond market. This allows the manager to make decisions in an absolute return framework, where success is measured by the absolute level of return on an investment over a period of time, as opposed to a relative return framework where success is measured by performance relative to a benchmark.
Unconstrained bond manager can choose to tactically limit interest rate risk, while most traditional bond strategies are required to maintain a level of positive interest rate exposure that is similar to their market index, even when interest rates are rising. And they can dynamically adjust risk exposures over time – looking across a broad, global market place including all sectors of the fixed income market and global currencies for attractive investment opportunities.