Advisors and investors are turning to mutual funds with more flexible mandates to cushion their portfolios against the unknowns. During the first quarter, $12.2 billion went into global flexible funds, compared to $8.9 billion in the fourth quarter of 2010, according to Lipper. In addition, investors put $8.1 billion into multi-sector bond funds, which includes unconstrained bond funds, up from $1.7 billion in inflows during the prior quarter, Lipper said.

One motivator is all the bad events and worries making headlines. Japan, the world's third-largest economy, has been utterly disrupted by earthquakes; the Middle East is a cauldron of political unrest; Europe has a sovereign debt crisis; and the U.S. is running huge deficits. On top of that, investors are also looking to protect their portfolio against interest rate and inflation risks.

“You have a lot of uncertainty in the markets,” said Matthew Lemieux, research analyst at Lipper. Investors are concerned over how the next news event could impact their portfolios, he said.

“Go-anywhere” funds give managers more flexibility to flee poor asset classes and industry sectors and head for better alternatives, Lemieux said. Mutual funds with a specific mandate have a narrower focus, so it's harder for managers to adjust to the movements of the market. With flexible funds, managers are not boxed in by style or sector, he said. These types of funds gained some momentum in 2008 as well.

Reacting to the Markets

Brett Horowitz, vice president and wealth manager at Evensky & Katz, allocates 30 percent of his clients' bond portfolio to the PIMCO Unconstrained Bond Fund (PUBAX), which has sold off all its Treasuries, and the J.P. Morgan Strategic Income Opportunities Fund (JSOAX), both of which accounted for almost half of the total flows into multi-sector funds in the first quarter. According to Lipper, the PIMCO fund drew in $1.5 billion, while the J.P. Morgan fund saw $2.25 billion in inflows during the quarter.

Evensky & Katz decided to put clients into these unconstrained bond funds to minimize client losses or break even in the event that interest rates go up, Horowitz said. The firm typically uses plain vanilla, safe bond funds aimed at preserving capital, but if the firm stuck with a big bond allocation, clients would suffer losses if interest rates were to rise. He said it was a difficult decision for the firm to make, given its conservative approach to bond investing, but it was a risk they're willing to take.

John Lekas, president, CEO and senior portfolio manager at Leader Capital Corp., runs the Leader Total Return Fund (LCTRX), an opportunistic bond fund. Lekas said he can vary the duration of the fund from seven to eight years down to zero, so it can carry high amounts of cash if needed. Being able to hold cash can limit interest rate risk, he said. Lekas also has the flexibility to move between foreign bonds, domestic bonds, high yield, corporates and government bonds.

“People are just sort of willing and able to be less pure about things,” said John Sterba, president of Investment Management Advisors, a registered investment advisor in New York.

Over the years, Sterba has broadened his use of flexible funds from smaller accounts to more general accounts. He has about 10 to 15 percent allocated to such funds, including BlackRock's Global Allocation Fund (MDLOX) and the Ivy Asset Strategy Fund (WASAX). Arguably, these funds can weather the storms and deliver returns by adapting to whatever market is in force, Sterba said. “No one is that great of a genius, but you hope they get it right more often than not.”

Rehmann Financial also allocates to the BlackRock Global Allocation Fund as well as flexible bond funds such as the Templeton Global Bond Fund (TPINX) and the Pioneer Strategic Income Fund (PSRAX), said Frank Germack, director of the investment department. Germack said he relies on these managers to find the best sources of performance through tactical and timely trades. The consensus is that interest rates are expected to go up, and these flexible bond funds are positioned to perform better in that environment because they can get exposure to the floating rate market, inflation-rate bonds, international fixed income and loan bonds, he said.

The Pie Chart

One of the drawbacks of these types of funds is that they don't easily fit into an advisor's asset allocation model, said Germack. He puts the BlackRock Global Allocation Fund into a world allocation bucket.

Sterba fits these funds into a “specialty” category, a catch-all that may include merger arbitrage strategies, long-short, market-neutral, convertible funds and these flexible funds.

Horowitz categorizes them as bond funds, but separates them out from the traditional bond allocation. He also makes sure clients understand that the allocation is not meant for excess returns, but to minimize potential losses related to interest rate risk and credit quality concerns.

Lipper's Lemieux said he would expect these funds to act more as a hedge, cushion or added part to a portfolio, rather than part of the core allocation.

But these funds do have risks associated with them. Before investing, Sterba makes sure that either the fund has been around long enough or that the manager has done well with other funds he's managed. Giving managers more flexibility can be very dangerous if they get it wrong, Sterba said. “It's like giving them enough rope to hang themselves.”