Is 2013 a 2008 moment for bond investors?

Bond investors are going through something they've never experienced before: Their fixed-income portfolios are getting whacked. Many are fleeing — and may not come back for a long long time.

Over the past month, Troy, Mich.-based financial adviser John Benedict has received a number of calls from clients asking a question he hasn’t heard in more than five years.
More than 600 miles away, in New York, adviser Erika Safran has been getting similar calls.
The same scene is playing out with clients across the country, more and more of whom want to know why they don’t own more stocks.
That’s right. After more than five years and more than $1 trillion of deposits into bond mutual funds, investors are finally starting to covet the outsized returns that the stock market has been producing.
And it is all thanks to the recent cracks in the bond market, which is giving investors something that a multiyear bull market in stocks couldn’t: an appetite for risk.
“It’s the first time since 2008 that the financial crisis feels like a distant memory,” said Mr. Benedict, chief executive of J2 Capital Management Inc.
When he has tried to push back and remind clients why they have an allocation to bonds in the first place — to lower volatility and reduce risk — he has met resistance.
“What we’ve received back is, ‘Why wouldn’t I get higher return now if I can get it?’ As if it’s a free lunch,” Mr. Benedict said.
Investors’ willingness to take on more risk is just starting to show up in fund flow data.
Equities took in $13.6 billion in the week ended July 10, the largest weekly inflows in four months, according to Bank of America Merrill Lynch Global Research.
Bonds, meanwhile, suffered their sixth straight week of outflows.
If it has been awhile since advisers such as Mr. Benedict have had clients push them to take on more risk, it has been even longer since clients have had to worry about the bond side of their portfolios.
“The conservative investor is being punished,” said Ms. Safran, principal at Safran Wealth Advisors LLC.
“They’ve never had an event like this,” she said. “They look at their portfolio and it’s down 2% or 3%.”
In fact, the Barclays U.S. Aggregate Bond Index, to which more than $1 trillion in bond mutual funds are benchmarked, is on pace for its worst year ever and just its third year of losses since 1976. It was down 2.71% through July 12, its worst losses since it shed 2.9% in 1994.
For the past few years, advisers have been preparing clients for the possibility that rising interest rates will cause losses in bond funds, but the speed at which rates are moving has caught some clients, and advisers, off guard.
“I don’t think people were unprepared for a move in bonds, but they were unprepared for the velocity of the move,” Joe Kinahan, chief derivatives strategist for TD Ameritrade Inc.
That helps explains the adverse reaction that investors had last month as they fled fixed-income funds as though they were a house on fire.
More than $60 billion was pulled out of bond funds in June, the first month of net outflows since August 2011, according to the Investment Company Institute.
Unfortunately for advisers, they are likely to be dealing with even more clients who are unhappy with their bond holdings, because rate volatility isn’t going away anytime soon.
The Federal Reserve Bank and its chairman, Ben S. Bernanke, have tried to be as transparent as possible about their plans to continue or slow down their bond purchase program, but the market has been trying to read between the lines and get ahead of any changes.
“Investors are reacting to signals, not anything else,” said Kathy Jones, a fixed-income strategist at Charles Schwab & Co. Inc.
To make matters worse, there is less bond liquidity than there was before the crash, which makes any quick up or down move more exaggerated, she said.
“Broker-dealers are caught between regulations and not wanting to put capital at risk,” Ms. Jones said.
Some estimates have broker-dealers holding about $40 billion in corporate bonds today, down from $250 billion pre-crisis, for example.
In light of the continuing distress in bonds, the best thing that advisers can do is get clients to stick to their original plan.
“Remind them that’s why they pay you,” said Jason Chandler, head of the wealth management advisor group at UBS Wealth Management Americas. “Most people, when they see these changes in prices they want to do something, but most of the time best thing to do is nothing.”