Kip 25

A Flexible Bond Fund Prepares for Trouble

Metropolitan West Unconstrained Bond heads into an uncertain year ahead of its peers.

The four managers of Metropolitan West Unconstrained Bond (MWCRX) are hunkering down. As its name suggests, the fund, a member of the Kiplinger 25, can invest in any kind of debt with just about any maturity. The managers are using this flexibility to their advantage, positioning the fund for the rough times they see coming.

For starters, the MetWest team anticipates that the Federal Reserve will raise short-term interest rates once or twice in 2016. Although the yield of the 10-year Treasury bond, 1.8% in early February, has dropped since the Fed hiked rates in December, the managers see the 10-year’s yield rising to 3% over the long term (alas, they decline to divulge a more specific timetable). That’s a negative for investors because bond prices move in the opposite direction of rates.

MetWest also sees trouble ahead for corporate bonds (both high-yield and investment-grade) and emerging-markets debt. The reasons: falling commodity prices, slowing economic growth in China and increased doubts about the health of the global economy.

Because of these concerns, the MetWest team has built a portfolio with low interest-rate sensitivity and a large cash stash, which the managers plan to put to work when prices of corporate and emerging-markets bonds fall to bargain levels. “It’s a wait-and-act year,” says comanager Laird Landmann.

Not only have the man­agers put 14% of the fund’s assets into cash, but 20% is in high-quality commercial-mortgage-backed and asset-backed securities that, comanager Steve Kane says, “can be turned into cash quickly.” And despite concerns about corporate bonds, the fund has 18% of its assets in corporate IOUs. The fund’s average duration is a low 1.4 years. The figure suggests that if interest rates were to rise by one percentage point the fund would lose 1.4%. By contrast, the duration of the Barclays U.S. Aggregate Bond index is 5.4 years.

Because of the managers’ cautious approach, Unconstrained Bond held steady in a blah year. Over the past 12 months, it lost 0.1%, about the same as the Aggregate Bond index but less than the 2.6% loss in the average nontraditional bond fund. “We’re not beating our chests about our performance,” Kane says, “but the fund behaved defensively in a year when many of our peers suffered losses.” The fund currently yields 2.2%.

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