ETF Trends
ETF Trends

Unconstrained fixed income funds break from the traditional mold of index-based bond funds, allowing managers increased flexibility. It is a strategy that has increased in popularity in recent years and is accessible in the exchange traded funds universe, including with the newly minted WisdomTree Western Asset Unconstrained Bond Fund (NasdaqGS: UBND).

The WisdomTree Western Asset Unconstrained Bond Fund, which debuted today, is managed by California-based Western Asset Management’s Mark Lindbloom, Morningstar’s 2014 fixed income fund manager of the year.

True to the unconstrained strategy, UBND offers investors exposure to an array of fixed income assets with the new ETF’s largest holding being a 16.5% weight to U.S. Treasurys maturing in 2014. The new fund also holds mortgage-backed securities, corporate bonds and foreign sovereign debt, among other bonds.

“Despite the name, unconstrained strategies are not undisciplined—a focus on risk is essential to management of these strategies. The specific level of risk that the manager targets is a primary differentiating factor among unconstrained strategies; some target bond-like volatility, while others are more opportunistic and target much higher levels of risk. As we outline below, an unconstrained approach to fixed income may help investors navigate today’s particularly uncertain market environment,” according to a WisdomTree research note out today.

UBND has a weighted average coupon of 5.19% and an average years to maturity of 11.47 years. Indicating that the ETF is right for a time in which fixed income investors are increasingly skittish of changes in Federal Reserve policy, UBND’s effective duration is zero. [Alternative Bond ETFs for a Rising Rate Environment]

Zero duration ETFs hold long-term bonds, but they will take short positions in Treasuries or Treasury futures contracts to hedge against potential losses if interest rates rise. The short positions would essentially diminish the funds’ duration – a measure of sensitivity of the price of a fixed-income asset to changes in interest rate risks, so a low duration would translate to a smaller sensitivity to shifting rates. Moreover, as yields have been inching higher and Treasury bond prices fell over recent weeks, the short Treasury positions helped bolster returns in the rate-hedged bond ETFs. UBND holds short positions on 10-year Treasury futures and long-term Treasury futures. [Fixed-Income ETFs That Beat Interest Rate Risk]

“As the Federal Reserve (Fed) looks to lift rates for the first time in nearly a decade, we believe that interest rate risk is likely to serve as a headwind rather than a tailwind going forward. In this investment environment, investors should ask themselves if the Agg’s current composition is reflective of their investment goals. As government issuance has risen in the United States, will this subset of the market offer compelling opportunities for income given the current interest rate environment? Put simply, an index is a reflection of issuance, not value,” according to WisdomTree.

UBND’s 40 long positions are mostly highly rated with 28.3% of the fund’s weight rated BBB and another combined 28.1% rated AA or A.