By Nathan Greenwald

With treasury bond yields at unappealing levels and widespread consensus that U.S. government bonds will provide poor absolute and relative returns for the foreseeable future, investors and advisors are seeking out new avenues for yield and safety. As such, some bond funds are using alternative investment approaches that seek out new returns and assume different risks.

One potential avenue are so-called "unconstrained" bond funds, also called "go-anywhere" funds, that invest in any part of the bond market--from treasuries and munis to corporates and emerging market debt and beyond. They can do so at any maturity point, average duration, or average rating. Some funds even short bonds by making bets against individual bonds.

But in some ways these funds also mimic the approaches of bond fund titans such as Dan Fuss of Loomis Sayles and Bill Gross of Pimco, whose behemoth funds have built long-term stellar track records by eschewing benchmarking and seeking out relative value in disparate patches of the bond market. The new generation of unconstrained funds are trying to emulate their worthy predecessors.

For advisors who evaluate investments on their ability to minimize tracking error and to generate alpha, these funds do not conform to traditional standards. Their fees are higher than index funds. For example, the Pimco Unconstrained Bond A (PUBAX) charges 1.3% annually, while the JP Morgan Strategic Income Opportunities A (JSOAX) dings investors for 0.88% a year.

And their collective performance in 2011 was disappointing. Funds in Morningstar's "non-traditional bond" category lost an average of 1.7% in 2011, while the largest U.S. bond benchmark--the Barclays Capital U.S. Aggregate Bond Index--gained more than 7%.

Are go-anywhere funds worth it? For some advisors concerned about the potential for a prolonged rising rate environment, these funds have become invaluable tools in asset allocation.?
"We have been using these funds for ten years," says Jim Holtzman of Legend Financial Advisors in Pittsburgh. Holtzman currently devotes half of his 30% income allocation in client portfolios to unconstrained bond funds.

Holtzman says that these funds allow him to achieve current income while protecting against rising rate scenarios. "The devil in the details for these funds," he says. "While interest rates are trending downward, they will move upwards at times. We are in a period of volatile interest rates, and it's nice to have managers who can make changes on the fly instead of making wholesale changes to asset allocation at the client level on our end."

Holtzman says he likes funds that invest in multiple asset classes, and particularly favors funds with high floating rate exposure, which will help lessen the impact of rising rates. In that vein, he prefers funds from well-known families such as Loomis Sayles and Pimco. Another fund he likes is the Osterweis Strategic Income fund (OSTIX), a multi-sector bond fund.

"We like using the research capabilities and due diligence abilities of these managers to invest in these asset classes," Holtzman says. "High-yield bonds and bank loans can be illiquid and difficult to evaluate."