The bond market is at an interesting, and crowded, intersection.
It's interesting because the Fed's extraordinary stimulus measures continue to keep a lid on interest rates, pushing some bond yields into negative territory after inflation. When and how far the Fed eventually pulls back is a much-discussed topic (even inside the Fed itself), but in the meantime, bond-market investors must deal with the repercussions of the Fed's past, present, and unknown future actions.
It's crowded because, despite such paltry yields, investors have put a lot of money to work in fixed income in recent times: More than $300 billion in new assets have flowed into bond funds during the past year.
Why are so many happy with such cloudy prospects? Past returns are undoubtedly part of the story. Intermediate-term bond funds gained 7% last year--not as much as the stock market, but not bad for an asset class that has long looked unattractive versus equities, at least based on the fundamentals. (Other factors like demographics--baby boomer retirees reallocating into bonds--and cash investors seeking some trace of yield are also undoubtedly contributing to bond fund flows.)
So where does that leave bond investors today? After a mediocre first-quarter performance for fixed income, the question is certainly still a timely one. During Morningstar.com's Future of Fixed-Income Week, April 15-19, we examined the possible scenarios for bonds (core, muni, and the more aggressive sectors) and how bond investors can set realistic expectations. We checked in with some top-rated bond managers--Dan Fuss of Loomis Sayles, Met West's Tad Rivelle, Steve Walsh of Western Asset, and Fidelity's Ford O'Neil among others--as well as Morningstar's own experts to get perspective on the lay of the land. And our director of personal finance Christine Benz helped investors translate the insights into a practical portfolio plan.
Recap: Expert Insights
Watch exclusive interviews with Morningstar analysts and other noted fixed-income experts from our Future of Fixed Income Week.
Jack Bogle: Vanguard Founder and Former Chairman
"I think we have to fix the [total U.S. bond market] index. ... What we are dealing with is huge amounts [of the index] that are held not by U.S. investors, but foreign investors. ... The government position in the index should be about half of what it is, maybe a third of what is." Click to watch the full interview (transcript included) ...
Dan Fuss, Portfolio Manager of Loomis Sayles Bond
"Right now, bonds are, relative to history and expectations, overpriced in general. ... It's time to be more cautious on credit risk ... You don't run away from it, but you have to become very selective and you can't just buy an index of a high-yield market." Click to watch the full interview (transcript included) ...
Tad Rivelle, Portfolio Manager of Metropolitan West Total Return Bond
"The wrong reason to be investing in bonds--or at least a diversified-bond type fund--is with an expectation that you are going to see anything like the kinds of returns that you've seen in prior years." Click to watch the full interview (transcript included) ...
Ford O'Neil, Portfolio Manager of Fidelity Total Bond
"With the starting yield on the Barclays Agg a little under 2% and spreads, in our opinion, having tightened quite a bit in 2012, ... our return expectations are a more modest zero to 4% range. Forget about those mid- to high-single-digit numbers that [your bond investments] have returned for five, 10, 30 years. I think the key is, more modest return expectations going forward." Click to watch the full interview (transcript included) ...
Steve Walsh, CIO of Western Asset Management
"I suppose if there is a fear or a risk, it's that investors ... might not fully appreciate the impact of what a lot higher interest rates would do to bond returns. But I'd like to think generally ... people recognize that the sort of flamboyant returns bonds have given investors over the last few years are actually probably not repeatable." Click to watch the full interview (transcript included) ...
Mark Vaselkiv, Portfolio Manager of T. Rowe Price High-Yield
"This is the first time in [my] history of managing the fund--I've now been the portfolio manager of T. Rowe High-Yield for 17 years--and we've never seen the yield dip below 5%. ... I think a good manager can still find some special situations and ... tease out a little bit more capital appreciation to supplement [that] 5% income stream, but 5%-6% annually is probably a reasonable expectation [going forward for high-yield bonds]." Click to watch the full interview (transcript included) ...
Tom Atteberry, Portfolio Manager of FPA New Income
"There's a tremendous amount of risk involved in the [bond] market. ... I can identify the risk and I can quantify the risk. The thing that I don't know is, when does this event start? ... So shouldn't I position myself to be able to survive that negative event in the bond market because really all I don't know is just when is it going to start?" Click to watch the full interview (transcript included) ...
Mark Sommer, Muni Portfolio Manager for Fidelity
"From my perspective, I think the answer when you're not being compensated for risk is, how do you take less, not how do you take more. That's not to say there are no opportunities, ... but I'm not subscribing to broad risk-taking, given where yields and spreads are." Click to watch the full interview (transcript included) ...
Jeff Westergaard, Morningstar's Director of Municipal Analytics
"Municipal governments have been under pretty severe stress as a result of the financial crisis .... In the case of Stockton and San Bernardino, Calif., you certainly are seeing those stresses being reflected in bankruptcy, which in and of itself is very, very unusual ... That being said, we don't believe this is the start of some pervasive wave of bankruptcies across the country. In fact, we think the asset class overall remains extraordinarily safe in terms of risk of default." Click to watch the full interview (transcript included) ...
Miriam Sjoblom, Associate Director of Fund Analysis With Morningstar
"If you're looking into the core ... intermediate muni space, I think going with a team that has a really solid research bench [is key]. We've seen a lot of headlines about muni credit troubles and by and large those have been isolated instances, but it's really the research team that can help your fund avoid trouble spots." Click to watch the full interview (transcript included) ...
Eric Jacobson Senior Fund Analyst With Morningstar
"I think there is a recognition [among bond fund managers] that spreads are getting tighter. You're starting to hear managers talk about it being more the bond-pickers market than a broad opportunity.... But let's face it, there is also a general need on the part of bond managers to compete with each other based on yield." Click to watch the full interview (transcript included) ...
Christine Benz, Morningstar Director of Personal Finance
"Obviously, it's a tough time for fixed-income investors. When I go out and about, the main think I hear about is bonds and how people should manage their bond portfolios. ... Yields are really low; prospective interest-rate hikes could crunch bond prices. Should I just forgo this asset class in my portfolio altogether? Let's talk about how you would approach this question." Click to watch the full interview (transcript included) ...
Monday | Bond Bootcamp
- Bond-Fund Basics
- For Bond Risks, Look Forward, Not Back
- Get Under the Hood of Bond Funds
- Bond Fund Duration: An Art, Not a Science
- Don't Overlook the Risks of Individual Bonds
- What's the Difference Between 'Maturity' and 'Duration'?
Tuesday | The Outlook for Core Bonds
- Fuss: Time for Caution and Selectivity in Bonds
- O'Neil: Bonds Poised for More Modest Returns
- Rivelle: Fed Casting a Very Long Shadow on the Bond Market
- Walsh: No Bond Bubble
- Walsh: It Could Get Bumpy When Fed Tightens
- Are Corporate Bond Investors Getting Paid Enough?
- Video Replay: Where Bond-Fund Skippers Are Sailing
- How to Find the Best Core Bond Funds
- These Core Bond Funds Earn Top Marks
- For Safety-First Savers, Stable-Value Funds Are Tough to Beat
Wednesday | What Next for Muni Bonds?
- What to Look For With Muni Funds
- Muni Defaults Not the Start of Broader Trend
- Fidelity's Sommer on Avoiding Potholes in Municipal Bonds
- These Core Muni-Bond Funds Earn Top Marks
- High-Yield Muni-Bond Funds to Spice Up a Muni Portfolio
- Do Municipal Bonds Have a Place in My Portfolio?
Thursday | High-Yield and Other Supporting Players
- Top 'Aggressive Kicker' Bond Funds
- FPA's Atteberry on Protecting Capital in Today's Bond Market
- The Great Yield Chase
- Vaselkiv: Set the Right Expectations for High-Yield Bonds
- Is High Yield Overvalued?
- Bank Loans Appealing but Far From a Cash Alternative
- Is It Time for Floating-Rate Bank Loans?
- Walsh: Eurozone Not Doomed but Has Rough Sledding Ahead
- Walsh: The Risks of Central Bank Activity
Friday | Building a Better Bond Portfolio
- Bogle: We Need to Fix the Bond Index
- Video Replay: Practical Strategies for Today's Bond Market
- Should You Rebalance Into (Gulp) Bonds?
- Find the Right Stock/Bond Mix
- How Much Foreign-Bond Exposure Do Retirees Need?
- How Much Should Retirees Stake in TIPS?
- How to Stress-Test a Portfolio's Interest-Rate Sensitivity