My Go-Anywhere Bond Fund Shines If You Ignore 2014 Gains

However you want to read Federal Reserve Chair Janet Yellen’s comments yesterday, managers of go-anywhere debt funds have the solution to your concerns.

Think she’s too relaxed about the level of froth in U.S. credit markets? They’ll take you overseas.

Think her interest-rate forecast is off? No problem, these funds can go short or long.

This pitch of flexibility is at least drawing investors’ cash, even if it’s not actually outperforming the market.

Investors funneled $3.2 billion into non-traditional bond funds in May, the most of any debt strategy. That brings year-to-date inflows to $19 billion, according to Morningstar Inc. data. They poured $11.2 billion into credit relative-value hedge funds in the first three months of 2014, even though they’re returning less than broad corporate-bond indexes this year, Hedge Fund Research Inc. data show.

“You’re hiring a manager who can move in and out of different pockets to generate some returns,” said Jack Flaherty, an investment manager at GAM USA Inc. in New York. “You have to be creative.”

The performance has been lacking of late. Non-traditional bond funds have returned 2.5 percent this year and an average 2.98 percent during the past three years, Morningstar data show.

Cash Flood

Investors who just bought dollar-denominated bonds fared better. Bank of America Merrill Lynch’s U.S. Broad Market Index has gained 3.5 this year and had an average annual return of 3.3 percent in the last three years. Go-anywhere funds have done better over the past five years, however, returning an average 6.2 percent compared with 5.1 percent for the market.

Investors keep piling into the unconstrained funds, though, as concern mounts that the debt rally is about to end. BlackRock Strategic Income Opportunities and Goldman Sachs Strategic Income funds each attracted $1.1 billion last month, according to Morningstar data. Last year, the funds beat benchmark indexes yet both are lagging behind this year, according to Morningstar.

The flows compare with a total $1.7 billion into the entire class of U.S. high-yield bond funds in May, the data show.

Last year, non-traditional bond funds did outperform when markets tanked in May and June on concern that a tapering of the Fed’s debt-buying would send yields soaring. The funds returned 0.3 percent, better than the 1.1 percent loss on company notes.

Of course, borrowing costs haven’t spiked yet. Yields on 10-year Treasuries have dropped to 2.6 percent from 3 percent at year-end as economists reduce expectations for growth and the European Central Bank accelerates its stimulus.

Yesterday, Yellen said interest rates will probably stay low “for a considerable time,” and downplayed concerns about quickening inflation and asset-price bubbles.

“The easy trade has come and gone; investors are slightly more critical at this point in time,” said David Tan, global head of rates at J.P. Morgan Asset Management in London. “We do know that markets cannot stay one way forever.”

The go-anywhere fund buyers are ready for the reversal.

Before it's here, it's on the Bloomberg Terminal.