I would be cautious about owning core bond funds when we are in a period of rising interest rates. Flat-to-lower rates are ideal for core bonds, but when times are less sure, hiring experienced, unconstrained bond managers seems to make sense.
I have no idea what will happen to interest rates and the bond market, whether we will get Bill Gross' "new neutral" of a 2% Federal Funds rate or what the Fed thinks will be a 3.75% neutral policy rate by the end of 20
17....and no idea what will happen to the US and world economies
People like David Swensen who runs the Yale endowment and wrote the book Unconventional Success, A Fundamental Approach to Personal Investment, strongly believe that we should only hold the highest quality bonds, Treasuries (both nominal and TIPS). Larry Swedroe also recommends only ultra high quality bonds. Swensen's reasoning is that bonds should play a very specific role in your portfolio, that of diversifying equity risk, especially for when equities go down. Take a look at how Treasuries performed in 2008 versus junk bonds, bank loans, and almost all bonds besides Treasuries.
The unconstrained bond funds generally have reduced average maturities, reduced duration. In many cases very significantly so. In exchange for the reduced interest rate risk, you generally get a very substantially increased credit risk. A significantly reduced quality of the bonds.
You mentioned great managers above, who manage great funds.
If the economy continues to recover, unemployment continues to decrease and eventually wages rise, etc, I'm sure the unconstrained bond funds in aggregate will do much better than the total bond market index funds like BND and AGG. And far better than Treasury bond funds. Taking credit risk instead of interest rate risk would be a good move if that plays out. But in the event that the economy and the stock market do poorly, the Treasury bond funds and total bond market funds should outperform the unconstrained funds in aggregate. This can be seen clearly in days like today, and other recent days when the stock market has done badly. Treasuries have done very well, and the total bond market funds have done fine also. They have diversified the portfolio just at the right time, when stocks did badly. Unconstrained bond funds, junk bond funds and lower quality bond funds have not diversified the portfolio that well at these times.
That's why Swensen and Swedroe only recommend the highest quality bonds, for portfolio diversification in the event that stocks or the economy do badly. Sort of as an insurance policy.
However, I can certainly see the great value in giving fixed income money to the managers named above and letting them invest it in an "unconstrained" manner, as they see best. JMO.
