Recently, I ran a Morningstar search to see how many taxable bond funds are available for investors to purchase. generic cialis
To my dismay, the search revealed over 3,300 fund choices (and this does not include municipal bonds funds, ETFs or closed-end funds). How on earth is the investment public able to decipher between so many choices? The mutual fund industry has taken full advantage of the bond sector’s stellar 30-year bull market to offer choices that would have been unimaginable even two decades ago. With the supermarket of choices available, we find that most investors fail to respect the breadth and complexity of the fixed-income sector. Unfortunately, the recent spike in interest rates is making investors realize that not all bonds and bond funds are equal.
What’s Really In Your Portfolio?
We have seen many new client portfolios where equity allocations were made with careful consideration, planning, and risk management. Meanwhile, their fixed-income allocations were more or less ignored; either they were invested in overlapping funds or had been caught up with a star manager or name while ignoring what is held in the portfolio. The biggest example of investors’ lax attitude towards fixed-income allocations and the potential risks they are ignoring is when our firm does research and due diligence on “total return” or “multi-sector” bond funds. We recently researched funds that consider themselves multi-sector or unconstrained funds. We narrowed the field down from over 300 funds to 12 based on certain quantitative criteria. Of the 12 funds, only one had a mandate against investing in common stocks. The last time I checked, most investors decide to buy a bond fund to get exposure to bonds, not stocks!
The recent spike in interest rates is making investors realize that not all bonds and bond funds are equal.
Traditional Bond Management
In my experience, bond management traditionally focused on 1) making sure that principal is returned and coupons can be paid 2) managing yield curve and interest rate risk and finally 3) after other considerations would come capital appreciation of a bond portfolio. Today, many total return and multi-sector managers seem to be looking at that list in reverse by first focusing on capital appreciation, with a return of principal and the ability to pay coupons coming up a distant last place. There are many reasons why this is happening, but one has to wonder if the ultra-low interest rate environment the Fed has created might be the biggest culprit for excessive risk taking in the bond market. It is hard to charge an expense ratio of 0.80–1.00% if short-term interest rates are close to 0%, but I digress.
You Need to Know What’s In Your Bond Portfolio
Now, I’m not writing about this to fault or point fingers at bond managers for investing in numerous fixed income sectors, currencies, countries, or even preferred or common stocks. My point is that it is very important that you understand what is held inside your bond portfolio and that you are comfortable with the risks the manager is taking when investing your money.
We know what is held in our clients’ bond portfolios, do you know what is held in yours?