Fund firms finally having "that conversation" with clients

There is nothing quite like seeing $60 billion in net outflows from bond mutual funds to get the financial services industry focused on how rising interest rates can affect fixed-income investments.

Last week, The Vanguard Group Inc. issued a report touting the long-term diversification benefits of bonds in a portfolio. Vanguard even hosted an online discussion on Facebook to help investors understand the virtues of fixed income.

Also last week, Genworth Financial Wealth Management Inc. said it is adding a “back to basics” bond education presentation to its quarterly meeting with financial advisers.

And in his latest analysis, Bill Gross, co-founder and co-chief investment officer of Pacific Investment Management Co. LLC, urged bond investors to stick with fixed income.

“Everybody knows they have a problem right now, especially after seeing record outflows from bond funds last month, and that’s probably not the last of it,” said Scott Colyer, chief executive and chief investment officer at Advisors Asset Management Inc. “Our clients are financial advisers, and we have been holding classes on learning to play defense on fixed-income management.”

“There are a lot of misconceptions coming from advisers who have spent their entire careers in a 30-year bull market for bonds when it was hard to get it wrong,” he said.

All this interest in educating the public about bonds is going on as the Federal Reserve inches closer to reducing the pace of $85 billion a month in Treasury bond and mortgage purchases. Indeed, the latest statement from Fed Chairman Ben S. Bernanke indicated that tapering will likely begin this year.

Although the decrease is expected to be gradual, the reality of rising rates has clearly rattled some segments of the fixed-income markets, and those firms with a vested interest in bond portfolios are scrambling to get ahead of the growing panic.

According to Mr. Colyer, virtually every traditional bond strategy should be re-evaluated.

“Even if you plan to hold a bond to maturity, you will have challenges when rates start rising,” he said. “If that maturity is nine years out, that’s an awful long time to receive negative phone calls from your clients.”

WAKE-UP CALL

Seeing $60 billion worth of net outflows from a category that hadn’t seen a single month of net outflows since August 2011 has clearly been a wake-up call for the financial services industry. And the industry appears to be responding with a full-blown educational assault.

Time will tell if the response will amount to too little, too late.

“We’re planning to put some material out to describe to investors where the right place to be is on the curve and how to develop a strategy for fixed income,” said Jim Colby, a senior municipal bond strategist and portfolio manager at Van Eck Global.

“I guess this is going to be a discussion for a lot of managers and advisers after clients pick up their June statements and are sorely surprised,” he said. “You can’t hide from what has happened, and you can’t hide from what the impact will be.”

Despite considerable chatter about the impact of Fed policy on rates, the central bank hasn’t actually done anything yet except make references to strategies that will eventually lead to higher rates.

The market, showing little interest in waiting for the Fed to act, has taken the opportunity to start moving out of bonds, a movement that has been showing up in the yield of the benchmark 10-year Treasury, which has experienced a 90-basis-point spike since early May.

“We started advising clients over a year ago to shorten their durations and to focus on high-grade and U.S. mortgage-backed securities,” said Hugh Lamle, president of MD Sass Investors Services Inc.

“One can no longer depend on rates going down and supplementing low yield with price appreciation,” he added, illustrating the longer-running message against traditional fixed-income allocations.

Theodore Feight, owner of Creative Financial Design, is among the advisers unwilling to remain passive.

He thinks that plenty can be deduced from how financial companies are reacting.

“If it’s a bond fund company, they are trying to say that everything will be OK and that you should stay with your allocation to fixed income and the world will be fine. But I don’t know how some of those companies are going to survive this,” Mr. Feight said. “We have sold all of our bonds, and right now we’re sitting on large-value, large-growth and small-cap stocks.”

That kind of perspective and dire outlook for bonds is what gives the fund industry nightmares.

“We started talking about this stuff a year and a half ago and we found that investors weren’t very receptive to it, but it’s usually not until after the horse has left the barn that everyone starts to try and figure out what to do,” said Adam Patti, chief executive of IndexIQ.

[email protected] Twitter: @jeff_benjamin

Related Topics: Vanguard Group