Turning Bonds into Stocks

I’ve spent the entirety of the post-crisis ZIRP period laboriously documenting trends in asset management and portfolio construction. I’ve written and talked about it all, in great detail, perhaps more so than any other market commentator in the world. I begin this way to give you a bit of background for what I’m about to say next…

One of the most dangerous things an investor can do to a portfolio is to seek bond-like returns from the stock market while taking de facto equity risk on the fixed income side. In English – to turn their bonds into stocks and their stocks into bonds.

Buying high-yielding dividend stocks for their current income and pretending they are “bond-like” is a recipe for nasty surprises at some point down the line. But this is precisely what many in the industry have been doing – financial advisors, ETF providers, money managers – everyone’s playing.

Taking equity-like risk on the fixed income side of a portfolio, however, is arguably even worse. In fact, I think it’s the biggest mistake that investors are making right now. By plowing into “Unconstrained Bond Funds”, they’re attempting to avoid the risk that interest rates rise while still getting the benefits of fixed income in the context of an asset allocation portfolio (non-correlation, stability of principal, etc). The problem is, you cannot actually do this in real life.

unconstrained bond

When I began my Fortune Magazine column this past fall, my stated intention was to shine a light on the nexus of how things happening in the real world were intersecting with things happening in the investment markets and on Wall Street. In my brand new column, which is number one right now on the Fortune website, I look at the way seven years of zero-percent interest rates have driven investor behavior in bond funds. By denying the link between heightened risk and heightened reward, investors are merely jumping out of the fire and into the frying pan.

I hope you enjoy it and get something useful out of this. Special thanks to my wealth management firm‘s director of research, Michael Batnick, for working with me on the data needed to put the whole puzzle together.

The biggest mistake investors are making right now (Fortune)


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