Unconstrained Investing: What It Means, How It Works

What is Unconstrained Investing?

Unconstrained investing is an investment style that does not require a fund or portfolio manager to adhere to a specific benchmark. It allows managers to pursue returns across many asset classes and sectors.

Key Takeaways

• Unconstrained investing allows fund managers to pursue investment themes and ideas without tying them to a specific performance benchmark like the S&P 500 Index.
• This flexibility gives managers the ability to take advantage of market changes in a timely manner.
• However, it also increases investment manager risk. Managers who operate more independently could make poor decisions that hurt a portfolio.

Understanding Unconstrained Investing

Unconstrained investing rose to prominence, in part, from the mistrust surrounding the 2007-2008 Financial Crisis. Investors were wary of the market, as well as benchmarks such as the S&P 500 Index or Russell 2000. Finance professionals often use benchmarks to determine whether the performances of the portfolios they select and manage are meeting expectations.

Fund and portfolio managers generally stuck closely to guidelines and measured their performance against fixed benchmarks. This inflexibility meant that managers were not always able to take advantage of market changes in a timely manner. It also meant that portfolio managers were highly invested in the U.S. market, which happened to be sitting on top of a subprime mortgage bomb that seriously shook up the financial markets when it went off.

Unconstrained Investing as an Alternative Style

Unconstrained investing focuses on long-term performance rather than short-term gains. It also eschews constraints that arise from benchmark tracking.

For example, in fixed-income investing, managers are not required to adhere to specific bond ratings, currencies, or sectors as these requirements may only apply to a portion of the portfolio. Bond portfolio managers are allowed to use derivatives to hedge against price and rate ranges, as well as to bet against the market throughput and call options.

This can cause portfolios to see an increase in investment manager risk, since inexperienced managers without guidelines or those operating more independently could make poor decisions that affect the value of the portfolio. Managers are entrusted with understanding not only how different asset classes and sectors interact, but also how different geographies and governments impact performance.

It is worth noting that there will still be internal performance metrics and controls designed to measure and control risks. The main difference is that a popular market benchmark will not be the main focus of the metrics.

Access to Unconstrained Investing Styles

While some teams develop their own styles, established asset managers like J.P. Morgan also have unconstrained strategies that many accredited and high-net-worth individuals can invest in.

On its website, J.P. Morgan describes how its managers pursue unconstrained investing strategies by researching and developing their best ideas across a wide range of asset classes, security types, and sectors. Another way to describe unconstrained investing is a multi-sector, multi-asset, global approach.