A negative duration bond strategy can give investors a way to profit from rising rates and lower bond prices by taking a "short" bond position through Treasuries and/or Eurodollar futures. Conversely, a negative-duration portfolio could underperform or even suffer losses if rates fall.
And if the Fed doesn't raise rates, investors in funds including the Pimco Unconstrained Bond Fund, which had a negative duration of 0.68 years as of July 31, and the Putnam Diversified Income Fund, which had a negative duration of 1.54 years as of July 31, will likely be disappointed if bond prices rise.
A Putnam spokeswoman wrote in an e-mail that the company believes its Diversified Income Fund is well positioned for investors, given that traditional multi-sector bond funds expose investors to interest rate risk, while often underusing other areas of fixed income such as credit risk, prepayment risk and liquidity risk.
"There has been much frustration by investors relative to core bond funds because these unconstrained funds have been positioned for rising interest rates and we have only seen Treasuries rally," said Marc Seidner, chief investment officer for non-traditional strategies and lead portfolio manager of the $7.9 billion Pimco Unconstrained Bond Fund.
As an example, the $20.4 billion Goldman Sachs Strategic Income Fund performed well during the "Taper Tantrum" of the summer of 2013, as it shorted Treasuries, thus having negative duration, and delivered a positive return of 1.47 percent. By year end, the fund's total return was 6.43 percent.
The Goldman portfolio had a negative duration of 5.3 years at the end of July 2014. However, that same negative duration turned out to be a two-edged sword: In 2014, the fund was down 0.50 percent, a year that saw the 10-year Treasury yield fall from 3.029 on December 31, 2013, to 2.172 on December 31, 2014.
"It is not a timing product," said Michael Swell, portfolio manager of the Goldman Sachs Strategic Income Fund. "We aren't going to get it right all the time but our investment strategy is more right than wrong."
As of June 30, the Goldman Sachs Strategic Income Fund had a positive duration of two years. As of the end of last month, Goldman Strategic Income's duration was 0.75 years.
While many of these funds' duration can swing wildly from one month to the next, not all of them disclose their holdings and their portfolios' duration monthly.
Only 50 percent of funds in Morningstar's "non-traditional bond fund" category, which includes unconstrained bond funds, reported their duration to the company every month.
For example, the Virtus Strategic Income Fund discloses its duration and holdings quarterly.