Active Bond Funds with 5%+ Yields Shine Amid Fed Uncertainty

Key Takeaway

• Amid Fed rate policy uncertainty, actively managed bond funds offering yields over 5% may attract more investor interest.
• BlackRock's BSIIX and other unconstrained bond funds offer flexibility in volatile markets, with notable yields like BSIIX's 5.25%.
• Investors are advised to consider active strategies for portfolio balance and be mindful of fees and tax implications.

Active Management in Focus

With the Federal Reserve's recent decision to hold interest rates steady, citing a "lack of further progress" on inflation, Wall Street faces uncertainty regarding future rate policies. This ambiguity, coupled with divergent forecasts from major investment banks like Barclays, Bank of America, and Citigroup on the number and timing of potential rate cuts, has spotlighted the potential benefits of an actively managed approach to fixed income investing. Rick Rieder, BlackRock’s global chief investment officer of fixed income, emphasized the challenges of a flat to inverted yield curve and high inflation environment for passive index investors, advocating for the flexibility active management provides in navigating these complexities.

Unconstrained Bond Funds Shine

The appeal of unconstrained bond funds, such as BlackRock’s Strategic Income Opportunities Fund (BSIIX) and Flexible Income ETF (BINC), lies in their ability to adapt to changing market conditions. These funds, which can invest across a wide range of income-generating assets and manage interest rate sensitivity, have demonstrated resilience in volatile markets. For instance, during 2022, when the Federal Reserve initiated rate hikes, the average nontraditional bond fund outperformed its more traditional counterparts, highlighting the potential advantages of active management in uncertain rate environments.

Core and Core-Plus Strategies Gain Traction

As the rate climate remains uncertain, core and core-plus bond strategies are also gaining interest. These strategies, which include a mix of corporate, government, and securitized debt, offer flexibility to incorporate higher-yielding assets like high-yield bonds and emerging market debt. Vanguard’s John Croke pointed out the growing interest in letting professionals manage risk and identify opportunities within these categories, suggesting that active management can provide a safer harbor in turbulent financial seas.

Choosing the Right Active Strategy

Investors exploring actively managed bond funds must consider several factors, including the fund's role in their portfolio, the management team's approach, and the cost and tax implications of active management. Jaime Quinones, a certified financial planner, recommends a thorough review of a fund's mandate and strategy as a starting point. Meanwhile, actively managed funds like Hartford Total Return Bond ETF (HTRB) distinguish themselves by seeking value across the fixed-income market, with a focus on high-quality assets and a diverse portfolio that includes mortgage-backed securities and investment-grade credit.

Street Views

• Rick Rieder, BlackRock (Neutral on the Bloomberg Aggregate Bond index):

  "When you have inflation running higher and a yield curve that is flat to inverted, why would you want to own the index? A huge chunk of the [Bloomberg Aggregate Bond] index is long duration. Why would you want to own it?" "Today, having more tools at your disposal means you can eliminate the parts of the index that aren’t worth owning."

• Eric Jacobson, Morningstar (Neutral on nontraditional bond funds):

  "The category held up during 2022 – the year that the Federal Reserve began its round of rate hikes – with the average nontraditional bond fund sliding 6.1% that year, while the average intermediate-term core plus bond fund fell 13.4%."

• John Croke, Vanguard (Cautiously Optimistic on core and core-plus strategies):

  "We think that if you’re venturing beyond the comfort and confines of cash, a great place to start is in a core or core-plus active strategy that is still going to be tethered to a high quality U.S. investment grade universe." "This message of ‘let the professionals allocate risk and find those opportunities’ is something that we’re seeing some traction with."