BONDS: A PAIN IN THE ASSET ALLOCATION: SO MUCH CASH, SO FEW OPTIONS AS BONDS LOOK AS TOPPY AS STOCKS

Stock prices seem too high. Bond rates may be falling too far, too fast.

Further muddying the investment picture: Foreign markets, dragged by Asian tigers with tails between their legs, are suffering currency crises and high-profile failures of financial institutions.

Pity the planner who must find the right place for a simple 401(k) rollover – and ensure a reasonably stable income stream for his or her client.

Ask two dozen pros to describe their asset allocations for, say, a 55-year-old with a $300,000 lump sum rollover and – guess what? – most wouldn’t change a thing, given today’s capricious conditions.

Never mind the worry that the 30-year Treasury bond yield has fallen to 5.74% from 6% in just a month – the lowest level in 27 years – and may fall lower amid talk of deflation.

And ignore the fear that U.S. equities, while gaining last week after some nasty New Year shocks, are overpriced by old-fashioned yardsticks. (Indeed, the market value of all U.S. stocks exceeds the gross domestic product by a good 30%, observes investment research firm Crandall Pierce & Co. of Libertyville, Ill.)

Perhaps advisers are true long-term planners who want investors to stay the course no matter what. Or maybe they’re awaiting the big signal that will decide which course to take in 1998 amid unprecedented market conditions.

“Near term I’d say everyone agrees: long bonds,” observes Robert A. Brusca, New York-based executive vice president and chief economist of Nikko Securities Co. International Inc. “But six months from now it’s not as clear.”

Indeed, Mr. Brusca believes the Federal Reserve Board will hike interest rates later in 1998 as the Asian bang ends with a whimper and the economy and inflationary pressures heat up. His informal advice to asset allocators until then: “Spread out. Try to be neutral. And try to shift the moment it becomes clear” where the market is heading.

Some of the planners and advisers interviewed have no taste for bonds, while others want to
wade into junk. Some are avoiding traditional stock funds and shifting into specialty sectors, such as REITs and utilities. Others are content to sit on good old cash, at least for now.

“The sun, the moon and the stars are lined up in favor of the bond market,” says Robert Kapito, senior portfolio manager at Black Rock Financial Management in New York.

With Fed Chairman Alan Greenspan dropping words like deflation in his public remarks, even 5% T-bond yields shouldn’t be discounted. “If inflation is 1%, that’s a 4% real return,” says Mr. Kapito, whose firm oversees more than $52 billion in bonds.

And he thinks advisers should rethink their domestic and international asset allocations as crises in Asian financial markets continue to unfold. “It is just starting, and it’s 10 times worse than Mexico. It is unbelievable how big this is.”

But not every one is ready to jump into bonds.

“If someone came to me today with 10 years to retirement, I’d put them 100% in equities,” says S. Timothy Kochis, principal of San Francisco-based Kochis Fitz Tracy & Gorman, a firm supervising $230 million.

“Bonds not only are a bad deal for the long term, but now that interest rates have gone down (they’re) particularly risky,” he adds, noting that a rise in interest rates would torpedo the value of recently purchased bonds.

He’d place the $300,000 into all categories, domestic large-cap stocks to international small caps – but not all at once. “Most flesh-and-blood individuals wouldn’t go right in,” he concedes, adding that, all things being equal, he prefers Vanguard Group’s index funds.

In Ocala, Fla., Hugh Barndollar brushes aside comments that the market may have reached its boiling point. “Look back a year or two: It was too high then, too,” says Mr. Barndollar, who supervises $50 million. He is bullish on the financial industry, particularly the John Hancock Regional Bank Fund.

There’s always cash, of course. That’s where Robert Levitt of C
oral Gables, Fla.-based Evensky Brown Katz & Levitt would leave the lump sum – for now.

“A lot of confusion creates a lot of volatility,” Mr. Levitt says. “I don’t know (yet) how to take advantage of that volatility.”

Especially if a client needed to begin withdrawals in the next year or two, cash would be the investment of choice for Mark Bass, a principal with Pennington Bass & Associates in Lubbock, Texas.

reits are all right

“I’m more sensitive now to how much people will need in the next one to three years,” says Mr. Bass, a 25-year veteran of the $90 million-asset firm. “When the market dropped in ’73 and ’74, it came back, but it didn’t come back in a week.”

For investors with a longer time line, Mr. Bass probably would put 30% to 40% of the $300,000 in U.S. equities, 15% to 20% in foreign equities, 20% in bonds and 5% in cash. The remainder would go in a managed futures fund or a real estate investment trust.

Mr. Bass favors Templeton growth funds, both foreign and domestic. “We also keep a crystal ball that doesn’t work and a dart board handy.”

REITS also would play a role for Debra L. Morrison of Fairfield, N.J., who has $30 million under supervision and avoids “handcuffing” portfolios with interest rate-sensitive fixed income funds. “I wouldn’t go long in a bond position. It’s too stupid.”

Ms. Morrison would put 20% of the portfolio in sector funds, including REITs. (A favorite: Cohen & Steers Realty Shares, which she calls “an interest hedge against stocks or bonds.”) She also likes the health care and financial industries, although she notes the latter is sensitive to interest rate fluctuations.

Growth stock funds would make up another 30% to 35% of the portfolio, growth and income funds 20% to 25% and equity income funds 10%. Convertible and junk bonds would make up the rest. “We know some people are shying away from high-yields,” but she recommends Fidelity High Yield Fund.

Bill Bergstrom,
CEO of Roseville, Minn.-based Focus Financial Network Inc. also is high on high-yield. “The good ones are paying 8.5% to 9%, which is unbeatable.”

Besides, Mr. Bergstrom continues, current bond yields aren’t such a bad deal considering that the inflation rate is between 1.5% and 2%.

the trend is your friend

“People lose perspective,” says Mr. Bergstrom, whose firm has $300 million under advisement. “Relative to inflation, it is a competitive rate of return. I hear people say that they wish we could get back to the days of the 18% money market accounts. I can’t believe it.”

Someone with 10 years to retirement still should have about 25% of his or her assets in bonds, preferably short-term instruments, says Chris Hauswirth, principal with San Francisco-based Hauswirth & Dunn.

His firm recently increased bond allocations to 21% from 12% and dropped international holdings to 12% from 21%. “We were looking to get a little cautious,” he explains.

Mr. Hauswirth also is introducing utilities into the mix, with such holdings as Strong American Utility Fund composing 8% of the portfolio. “Utility stocks are generally undervalued,” he figures.

Kaycee Krysty of Seattle-based Tyee Asset Strategies is staying the course and not changing anything she’s done. Asset allocation has more to do with life expectancy than market fluctuations, she says.

The classic allocation formulas “are designed to last for 20 to 30 to 40 years,” she explains. “Clients retire at, say 65, and still can have another 35 years to live. But many investors hit retirement and then want to invest too conservatively.”

Donald Johnson, senior academic associate at the Denver-based College for Financial Planning, favors a steady approach.

“Ideally, they should come up with a long-term plan for a client. I don’t think it’s time to deviate because the markets go down.”

Or go up. Richard Bregman, principal of New York-based MJB Asset Management LLC, with $20 mil
lion under advisement, says there’s “nothing more tempting than small-cap European companies. But I can’t overweight it. I’m not Karnak.”