Bear market looms for bonds

M the name SG

Falling interest rates that made them attractive expected to reverse course, say experts

Watch out, bond holders.

Fixed-income experts warn that a long bear market lies ahead. Long-term bond returns will be modest at best, and negative at worst.

"We're in the foothills of a gradual rise in interest rates," said world-class bond manager Daniel Fuss, of the US$21.2 billion (S$26.7 billion) Loomis Sayles Bond Fund, at a recent press conference.

He predicts a 20-year trend of rising rates - a bleak outlook for bonds, whose prices fall when rates rise.

Bond fund managers warn that US Treasuries - still deemed the world's safest bonds - are particularly vulnerable because their yields are so low.

Many investors are ignoring such warnings, however, it is easy to see why: For the past three decades, interest rates have been declined, providing a tail-wind that has boosted average bond returns to 8.5 per cent a year since 1980.

Despite current low yields, investors have poured US$682.8 billion into bond mutual funds since the 2008 financial crisis, while stock funds experienced net outflows, according to Lipper, a unit of Thomson Reuters.

But current rates are far more likely to rise than fall.

Experts say it is time to stress-test your portfolios and lower your return expectations. Here is how they recommend adjusting your investments:

1) Don't dump bonds: Even if they do not provide real income, you need them for diversification.

"The role of bonds in a portfolio has been and always will be to mitigate the volatility of stocks," said Mr Chris Philips, a senior analyst at Vanguard's investment strategy group.

"Bonds are the true diversifying asset."

2) Check your vulnerability to rising rates: For a rough estimate of how much a bond fund may lose if Treasury yields rise by 1 percentage point over a 12-month period, subtract its SEC yield - which reflects dividends and interest earnings - from its current duration.

That is not a precise measure, but it gives you a sense of what can happen, said Mr Philips.

3) Reduce your risk: To cut risk, move some of your bond allocation into a fund with a shorter average maturity, and trim your exposure to Treasuries, whose low yield now lags inflation.

For example, you could shift money from Vanguard's Total Bond Index - which is Treasury-heavy-to Vanguard's Short-term Bond Index fund.

But do not eliminate Treasuries from your portfolio however meagre their yield, said Mr Joseph Davis, Vanguard's chef economist. They are the "flight-to-quality" diversifier - the refuge of choice when investors panic.

4) Don't chase yield: Resist the temptation to pile into junk (aka "high yield") or emerging markets bonds.

Despite their attractions, both tend to perform like stocks during periods of uncertainty, said Mr Ross Levin, a Minnesota wealth manager.

"You own bonds to protect yourself when things blow up. If you're nervous about long-term Treasuries, buy short-term investment grade bonds."

5) Don't depend on bond income alone: Retirees can protect themselves by investing for total return.

"When your bonds aren't kicking off enough income, you sell stocks and use some capital gains as income," said Ms Anna Pfaehler, a financial planner at Palisades Hudson in New York.

Reuters

invest, The Sunday Times, May 20 2012, Pg 37