Spike in bond yields makes equities an easier sell

QE2's unexpected result is helping advisers persuade clients to shift

By Jessica Toonkel

Nov 21, 2010 @ 12:01 am (Updated 2:17 pm) EST

Financial advisers are using last week's unexpected spike in interest rates to persuade clients that it's time to get out of long-term bonds and back into equities.

The spike is a result of the Federal Reserve's decision to buy $600 billion in Treasuries by the end of June in a bid to lower mid-and long-term interest rates. But market worries drove rates up last week even as the Fed tried to soothe fears with the message that its move will be beneficial in the long term.

Despite the plea for calm, prices on longer-term bonds continued to sag, boosting yields in the process. The yield on the 10-year Treasury hit 2.91% on Nov. 15, the highest since Aug. 5.

This unexpected result from the second round of quantitative easing has made it easier for advisers, many of whom have been trying to explain to clients about the potential volatility of bonds. Until recently, investors, still shellshocked from the 2008 market crash, believed long-term bonds meant safety, but advisers now say it's easier to get them to listen and move into equities.

“You are coming to an end of the bull market on interest rates,” said Nathan White, chief investment officer of Paragon Wealth Management, which manages $65 million in assets. “This makes people listen to us now.”

Advisers have been surprised to receive calls from clients asking about how the Fed move might affect their portfolios. “I have got a few calls from people asking how they can play the interest rate jump and whether they should buy an inverse-bond fund,” Mr. White said.

'TOO STIMULATIVE'

In a recent survey of 218 fund managers, almost half said they believe that the Fed's monetary policy after its latest move is “too stimulative.” As a result, fund managers' allocations to bonds have dropped. Thirty-six percent of fund managers responding to a survey conducted by Bank of America Merrill Lynch in November said they were underweight bonds, up from 24% in October. Forty-one percent of managers said they were overweight equities, up from 27% last month, according to the survey.

Paragon has been shifting clients from long-term-bond ETFs, such as iShares Barclays 20+ Year Treasury Bond ETF (TLT), into dividend-paying-equity ETFs such as the SPDR S&P Dividend ETF (SDY).

Similarly, Traphagen Investment Advisors LLC, which has $240 million in assets under management, has been moving clients from long-term bonds to shorter-duration bonds and dividend-paying stocks and funds, said partner V. Peter Traphagen Jr.

“Interest rates are harder to pick than stocks,” he said.

And with so much international opposition to QE2, it's hard to predict what's going to happen, said Gregory L. Olsen, a partner at Lenox Advisors Inc., which manages $1.2 billion in assets.

“It's completely possible that they will pull the plug and scale it back,” he said. “It's quite possible that equities have more safety than bonds at this point because right now, unless you are going to have an actual bond and hold it to maturity, which is not paying a lot, there is a good chance that you will lose money.”

Mr. Olsen is telling clients that dividend-paying stocks are a better hedge against inflation. “We have been taking the profits our clients made from bonds and reallocating them into alternatives and into equities,” he said. “We see less risk in stocks than bonds.”

Overall, Mr. Olsen has pared his clients' bond allocations to 20% from 30%.

Not everyone agrees that dividend-paying stocks are a safer play than bonds today. “We are not focused on dividend-paying stocks,” said Jim Holtzman, an adviser with Legend Financial Advisors Inc., which manages $380 million.

“Our concern is that companies can cut dividend rates. It's not so secure.”

E-mail Jessica Toonkel at jtoonkel@investmentnews.com.

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