A recurring theme in the financial media and blogosphere holds that financial advisors have grown complacent about interest rates and bonds. The last cyclical peak in 10-year Treasury yields occurred in September of 1981, 33 years ago. Ever since, we've been in a downward rate environment, which has provided a benign tailwind for bond returns.
Now, the theory goes, advisors are unprepared for an extended period of rising rates. As one blogger expressed it: "an entire generation of professional investors aged 22-60 has never invested during a bear market in bonds."
Are most of today's advisors "bond-complacent?"
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Based on the evidence, it's debatable.
The Investment Company Institute has published its 2014 Investment Company Fact Book here: http://www.icifactbook.org
Bond mutual fund cash flows are a useful barometer for measuring professional advice about fixed-income investing. For 2013, The Fact Book shows two revealing trends:
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In 2013, heavy net inflows to U.S. bond funds reversed dramatically, turning into a net outflow of $80.5 billion for the year. This was a record annual net outflow for U.S. bond funds. It stood in contrast to an average annual net inflow of $255 billion to bond funds for the period 2009-2012, during the "search for yield" phase that followed the Fed's zero interest rate policy (ZIRP).
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The "broad redemption rate" for bond funds increased from 30.2% in 2012 to 41.3% in 2013. (This rate adds redemptions and outbound exchanges and divides the total by average bond fund assets.)
In 2013, this data suggests that many financial advisors were advising clients to review and adjust bond holdings, in preparation for higher rates. In 2014, however, the same evidence is not so compelling. Year-to-date through the end of July, net bond fund inflows have been +$62.4 billion.
There is one good point in the bond-complacency argument – namely, advisors can be unconsciously influenced by the financial environment in which they have worked.
During year-end 2014 reviews, make sure to spend time reviewing bond holdings and helping clients understand that ZIRP is not permanent.
A little caution in reducing bond durations now may pay off in the years ahead – in terms of better portfolio returns, as well as clients' confidence in being prepared for a new era of rising rates.
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