Bloomberg Businessweek USA - October 30, 2017

33

Unconstrained (and Underwhelming) Funds

○ Bond managers who can go anywhere may end up in the wrong places

Leon LaBreque, a financial adviser from Troy,
Mich., was wowed back in 2011 when he heard
the pitch for the Goldman Sachs Strategic Income
Fund. It was a new kind of fixed-income port folio
whose managers had the freedom to buy just about
anything. Along with bonds, they might bet on
emerging- markets currencies or lend U.S. dollars
to Japanese investors—and they could draw on the
global expertise of Goldman Sachs. “The story was
so compelling, and the people were so smart,”
LaBreque says. “I thought, how could it not work?”
He wasn’t the only person looking for this kind
of fund, and Goldman Sachs wouldn’t be the only
company to offer one. By the early 2010s, bonds had
been in a decades-long bull market, and the Federal
Reserve’s benchmark interest rate was near zero,
with nowhere to go but up. Because bond prices fall
as rates rise, a nasty turn in the U.S. bond market
seemed inevitable to many. That made the idea of
a fund with the flexibility to make other kinds of
bets more appealing. “This portfolio has a shot at
making money in any rate environment,” said Mike
Swell, co-manager of the Goldman Sachs fund, in a
December 2013 interview with Bloomberg. Over the
next several years, many other mutual fund com-
panies introduced “unconstrained” bond port folios
with a similar pitch.
With strong initial returns, the Goldman Sachs
fund grew to an impressive $26 billion in assets
by 2014. But its performance deteriorated, the
result of mistimed calls on interest rates and the
strength of corporate credit. In 2014, for example,

THE BOTTOM LINE Thanks to psychological biases, markets

sometimes overreact or underreact to news. Figuring out which is

happening and when is the tricky part.

their thinking—if they take steps in advance to
protect themselves from their instincts. For
example, to slow down decision-making in the
heat of the moment, individuals can set rules in
advance about when they can sell a stock or a fund.
“If they find they don’t like those rules, they have
to change them and not just make an exception,”
says Wendel.
One of the most celebrated examples of a preset
system that short-circuits bias comes directly from
Thaler’s work. Psychologists have found that people
place a high value on saving—when they imagine
doing it in the future. In the moment, the tempta-
tion to spend is often stronger. And for many every-
day investors, the most difficult investment decision
is to set aside the money to begin with. Along with
behavioral economist Shlomo Benartzi, Thaler
developed a retirement savings system called Save

More Tomorrow. Participants commit in advance to

contributing a higher percentage of their salary to

their 401(k)s over time. A majority of large 401(k)

plans now have such an auto- escalation option.

The professional investors at Fuller & Thaler

also use systems to guard against their biases.

They don’t visit companies, says Giovinazzo—

because when you meet with people, you judge

them more on whether you like them than whether

they’re good leaders. To avoid anchoring, he and

his colleagues at Fuller & Thaler don’t set price

targets for stocks or make quarterly earnings fore-

casts. It’s good to know that markets can be irra-

tional, but it can only help if you recognize that

you’ll be, too. —Suzanne Woolley

the managers had positioned the fund to take advan-

tage of rising U.S. rates. Instead, rates fell sharply.

Over the past three years, its annual average return

has been slightly negative. LaBreque grew disillu-

sioned and withdrew his clients’ money, part of

a redemption wave that has cut the fund’s assets

down to $6.6 billion.

Other nontraditional bond funds have done

better, returning an average of 2.45 percent

annually over the past three years, according to

Morningstar Inc. Many benefited from the con-

tinued rally in plain- vanilla U.S. corporate bonds,

which also helped regular intermediate-term

bond funds earn 2.19 percent per year. Over five

 PERSONAL FINANCE Bloomberg Businessweek October 30, 2017