5 Multisector Bond Funds for Diversification and Income

The Touchstone Strategic Income has been adding higher-quality holdings such as mortgage-backed securities. (Justin Sullivan/Getty Images)

It’s been a tricky time for bond investors this year.

Credit spreads are tight in sectors such as investment-grade credit and high-yield bonds, a testament to lofty valuations. The Federal Reserve is expected to continue cutting interest rates. And there are longer-term concerns about the growing federal budget deficit and its impact on bond prices.

That’s why it makes sense for income investors to spread their bets across a variety of bond categories as a way to reduce risk.

Multisector bond funds are one way to do that.

“Instead of just making one bet within fixed income, diversify it with a more multisector, opportunistic fund,” says Anders Persson, head of global fixed income at Nuveen, who adds that “there are attractive opportunities beyond just the Treasury markets” and favors allocating across fixed income into assets such as municipal bonds and preferred stocks.

Morningstar defines its multisector bond category as funds that seek income by diversifying their assets among several fixed-income sectors, including U.S. government bonds, U.S. corporate bonds, foreign debt, and high-yield issues.

This approach can give fund managers more flexibility, says Paul Olmsted, a fixed-income strategies senior analyst at Morningstar.

“Instead of saying, ‘I just own high yield,’ they might say, ‘I’m seeing a good value opportunity in nonagency mortgage-backed securities or other asset-backed securities,’” Olmsted says.

Based on Morningstar’s parameters for multisector funds, non-investment-grade holdings can account for 35% to 65% of a portfolio’s assets. As a result, these funds can be riskier than a plain-vanilla bond portfolio. It’s important for investors to check out a fund’s allocation before they put money into it.

Because some of these funds can carry more risk with their weightings to junk bonds, investors should avoid putting all of their eggs in one basket. One approach for retail investors would be to own a more conservative fund for the majority of their fixed-income allocation and then supplement it with a smaller holding in a multisector fund.

“I would look at this as a complement to that core” bond fund holding, says Olmsted, who suggests such a move might be suitable for investors looking to generate more income.

Spreading Your Bets

Multisector bond funds offer diversification in the fixed-income markets, though they come with more risk.

Note: Returns through Sept. 15; three-year returns are annualized.

Source: Morningstar

Dan Carter, a manager of the $292 million Touchstone Strategic Income fund, says the portfolio’s allocation in riskier assets—notably high-yield bonds—is at the lower end of the range. On a scale of 0% to 100%, with 100% being the most aggressive, the fund is now between 30% and 40%, he says.

But after the high-yield market came under pressure in early April, following President Donald Trump’s Liberation Day tariff announcements, Carter and his colleagues did increase their high-yield holdings. They are now around 16%, up from 10% in early April.

“There was a bit of volatility there, and we added a little bit of risk to the portfolio,” Carter says.

He’s also been adding higher-quality holdings, such as commercial mortgage-backed securities and nonagency mortgages, among others.

“You can’t just go out and buy a sector and ride the wave,” says Carter. “You’ve had to focus a bit more on specific opportunities, now that spreads have gotten tighter.”

The fund’s average weighted yield was recently 5.65%, he says.

Another option for multisector funds is the $198 billion Pimco Income fund, whose holdings include a big slug of agency mortgage-backed securities, which comprised 36% of the portfolio as of August. It has dialed back its nonagency mortgage holdings to around 16% from 23% at the end of last year—but it has upped its exposure to other securitized assets over that time.

The fund’s managers include Dan Ivascyn, Pimco’s group chief investment officer. Its total return was 8.3% this year through Sept. 15, placing it in the top 10% of its Morningstar peer group. Its three-year annual return was 7.45%, good for the top 40%.

The Pimco Income fund has a trailing 12-month yield of 5.69%, according to Morningstar.

‘Elsewhere, the $19.5 billion American Funds Multi-Sector Income fund has a trailing 12-month yield of 5.99%. Its year-to-date return through Sept. 15 was 6.9%, besting more than half of its Morningstar peers; its three-year annual return of 8.1% ranks in the top 20%.

Olmsted says the fund has “a very capable team and a proven process.” As of June 30, corporate bonds, notes, and loans accounted for 65% of the portfolio’s assets, followed by mortgage-backed securities at 17%.

Another option for investors is the $14.7 billion JPMorgan Income fund, which has a trailing 12-month yield of 5.69%.

The portfolio managers look for good relative value. Securitized debt followed by high-yield corporate credits account for the lion’s share of the fund’s assets, according to Olmsted.

The fund has a total return of just under 6% this year, as of Sept. 15, placing it in the bottom half of its Morningstar peer group. It’s in the top half based on five- and 10-year periods.

Finally, the Loomis Sayles Bond fund has a trailing 12-month yield of 5.05%. As of Aug. 31, the fund’s largest allocation was in investment-grade credits (33%), followed by securitized assets (20%) and U.S. Treasuries (14%). The fund’s 7.64% performance this year ranks in the top 20% of multisector bond funds.

A crucial aspect for these funds is their flexibility, a valuable tool in the right hands.

“It’s an option for somebody that wants to derisk a little bit—but wants to do it in a responsible way,” says Olmsted. “At the same time, it allows you to take advantage of the high yields we’re seeing in fixed income.”

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