If you are unwilling or unable to forecast rate movements, then delegating fixed-income management – through an “unconstrained” bond fund – offers the hope of strong performance regardless of market environments. But the data show that over the last three years, unconstrained funds on average did not meet that goal.
The last three years were a good test laboratory for unconstrained funds. The 10-year rate was 3.36% on Jan. 1, 2011, and 3.04% on Dec. 31 of last year. With rates bottoming out in July 2012, the last three years saw roughly equal periods of falling and rising rates:
Using data provided by Morningstar, I compared the performance of unconstrained bond funds to intermediate- and long-term bond funds over this period. The data I used is provided in the appendix (PDF version only) and I will make a spreadsheet available upon request. I examined only funds that were in existence for all three years. I did not attempt to correct for survivorship or backfill biases.
I investigated the following questions:
- Did unconstrained bond funds outperform the other categories of funds on an absolute or risk-adjusted basis?
- Did low correlation to the bond market result in higher fund performance?
- Which bond-fund characteristic was a greater contributor to increased return: low correlation to the bond market or a low expense ratio?
The answers to those questions are provided below.
The results of the study
Below are the summary statistics from the study:
| Number of Funds | Total Ret Annlzd 3 Yr (Mo-End) | Std Dev 3Yr (Mo-End) Risk Currency | Correlation to Barclays US Agg, 1/1/2011-12/13/2013 | Correlation to BofAML US Treasury Current 10-Yea,r 1/1/2011=12/13/2013 | Annual Report Net Expense Ratio | Sharpe Ratio | |
| Unconstrained |
32 |
2.72 |
3.83 |
0.16 |
-0.12 |
1.20 |
0.84 |
| Intermediate term |
237 |
3.86 |
2.95 |
0.83 |
0.60 |
0.70 |
1.31 |
| Long term |
11 |
5.83 |
5.98 |
0.85 |
0.77 |
0.85 |
1.00 |
| AGG |
1 |
3.26 |
2.75 |
1.00 |
0.89 |
0.08 |
1.17 |
| 10-year Treasury |
1 |
2.79 |
| Average Correlation to AGG | Average Correlation to 10-year TSY | Correlation Between Return and Expense Ratio | Correlation Between Return and Correlation to AGG | Correlation Between Return and Correlation to 10-year TSY | |
| Unconstrained |
0.16 |
-0.12 |
-0.28 |
0.10 |
-0.15 |
| Intermediate term |
0.83 |
0.60 |
-0.27 |
-0.38 |
-0.45 |
| Long term |
0.85 |
0.77 |
-0.12 |
-0.12 |
0.21 |
See full article on The Verdict on Unconstrained Bond Funds by Robert Huebscher, Advisor Perspectives
