I spend a lot of my time talking to investors and financial advisors. And whether I’m giving an overview of BlackRock’s Strategic Income Opportunities Fund or offering my thoughts about the economy and bond markets, one question always seems to come up: What, exactly, is “unconstrained” investing? And is it something investors should consider?
There’s been more and more money pouring into unconstrained fixed income funds as many look for new ways to gain income amid low yields (a topic I wrote about a couple of months ago). There’s also been a lot of media coverage about this investment approach, so it’s not surprising that questions about unconstrained investing are popping with some degree of regularity.
Many market watchers seem to feel that unconstrained investing is a high-risk, undisciplined way to invest. But I would argue just the opposite—to me, unconstrained investing is a way to manage volatility while seeking out a variety of sources of return. Here’s how I answer the questions I get about this approach.
What Is Unconstrained Investing?
So let’s start with answering that first question. Simply put, unconstrained investing is a flexible, adaptable, go-anywhere approach that looks for opportunities across a wide set of asset classes and markets without the limitations imposed by a broad market benchmark.
Most traditional fixed income funds are managed against a specific market benchmark (such as the Barclays U.S. Aggregate Bond Index). In practice, that means the portfolio managers are tied to creating portfolios that look a lot like the index, with some narrow degree of flexibility. In this particular example, given that the Barclays U.S. Aggregate Bond Index is heavily comprised of Treasuries and other government-related debt, and given that these are the types of bonds most vulnerable to potential increases in interest rates, these traditional bond portfolios may be taking on more risk than many realize. Here’s more detail on this point.
In contrast, unconstrained funds are not tied to a specific index. That means they can access a wider and more diverse set of opportunities. In my mind, this means managers of unconstrained funds can work to avoid the risks they want to avoid and take on the risks that make the most sense for the investor. Additionally, unconstrained funds tend to be outcome oriented. In other words, many unconstrained funds are lined up with a specific investment objective (such as maximizing an income stream) rather than working to beat a benchmark. This feature makes them well suited for those investors focused on achieving that same outcome. Investors must also be aware that flexible strategies invest in a wider variety of bonds including, but not limited to high yield and emerging markets, and are more susceptible to credit risk.
What It’s Not
Some of the confusion about unconstrained investing comes about from the fact that these sorts of funds are not managed against a benchmark. But not being benchmark constrained doesn’t mean that these funds don’t have risk controls or guardrails.