Fixed income reminds Vanguard CEO of 1999

When Bill McNabb, chief executive of The Vanguard Group Inc., sees the valuations and yields available in fixed income, it takes him on a trip down memory lane. Unfortunately for bond fund investors, it isn't a rosy memory. “You could argue it's almost as extreme as stocks were in 1999,” Mr. McNabb said in an interview. That year, the price-earnings ratio for the S&P 500 bubbled up to more than 30 as stocks careened toward the technology bubble crash. The following decade was dubbed a “lost decade” for equities as the S&P 500 had negative annual returns. Mr. McNabb isn't predicting that bond funds will suffer the same fate over the next 10 years, but he is warning clients that they need to reduce their expectations. “It's always dangerous to predict returns, but the probability of bonds' having the same return over the next 10 years as the last 10 is almost zero,” he said. That doesn't mean that Mr. Mc-Nabb is advocating throwing bonds out of a portfolio or replacing them with riskier assets with higher yields.

"DIVERSIFIER OF EQUITIES'

“Bonds are still a great diversifier of equities,” he said. In fact, Vanguard contends that they are actually the best diversifier of equities during times of market stress. The diversification benefits have never been more costly, though. The 10-year Treasury is still yielding less than 2%, and the Dow Jones Corporate Bond Index is trading at a record high of 115. That means that returns on the classic balanced portfolio, with a 40% allocation to bonds, are inevitably going to be lower. Investors can expect closer to a 5% return from the 60/40 mix of stocks and bonds, down from the historical average of about 8%, Mr. McNabb said. [email protected] Twitter: @jasonkephart