Do the Right Thing—At the Right Time (Part 3)
In the last two blog posts we explored historical returns of bonds and the value of your ‘safe money’ today. Since January 2008 and continuing into early 2013, investors have put nearly one TRILLION dollars into bond mutual funds alone, while taking OUT nearly a half-a-trillion from stocks. That strategy can work for a while … as long as interest rates continue to fall. But now, if interest rates have nowhere to go but up, what could account for the seemingly illogical continuing flood of money into bond funds that are paying basically nothing?
The answer lies in investors usually doing the right thing but often at the wrong time. Investors pull money out of the stock market when it has fallen. They put money back in after things feel ‘safer’ (when the markets have gone up). Similarly, they put money into bonds and other yielding assets at historically low yields and drive those yields even lower. While the purpose of these actions is to attempt to lower one’s fear of risk, it may in fact have the exact opposite result.
Our research suggests that if—likely when—interest rates return to historically normal levels, bond holders could be left holding the bag. Long-term Treasury bonds alone could lose almost 20%—and investors would feel the pain of 2008 again—but this time in their ‘safe’ money.
So what is to be done about it? Fortunately, interest rates are likely to stay low for a while yet, making the current highest risk to bond portfolios the slow erosion of purchasing power by inflation. While there may be no cause for panic, though, do not wait to do the right thing—at the wrong time.
Our research offers that what we call ‘opportunistic’ yield-bearing investments can be a viable option and a graceful way to get away from lower-yielding government bonds and traditional investment-grade corporate bonds. Such non-traditional credit investments include Emerging Market bonds, bank loans, and mortgages. We also generally favor equities over fixed income in the current environment, and believe that an underweight in fixed income is likely a good strategic stance for the next few years.
The bottom line is: do not make the mistake of thinking that your ‘safe’ money is necessarily safe. This time, do the right thing at the right time.
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