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By Christine Benz | 07-10-2014 02:00 PM

Portfolios Look Stock-Heavy

After a years-long bull market, investors' equity stakes are near peak, which calls for caution and rebalancing, says Vanguard's Fran Kinniry.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com.

Have investors grown complacent in the extended bull market? Joining me to discuss that topic is Fran Kinniry. He is a principal in Vanguard's Investment Strategy Group.

Fran, thank you so much for being here.

Fran Kinniry: Thank you, Christine.

Benz: Fran, let's talk about investors' appetite for risk. When we look at fund flows, we've seen flows into equity funds ebb and flow, but it does appear that some investors might be getting a little bit complacent about the equity market--returns have been so strong for so long. Is that something you're seeing when you look at flows into Vanguard products?

Kinniry: What we're really seeing is that the giant bull market of the last five years has pushed equity allocations up. So, whereas the cash flow, as you mentioned, has been volatile in and out, when you have such a bull market, equity allocations are near peak. When we look at all mutual fund assets, there have only been two times where investors have had this much in equity--that is 1998 through 2000 and then in 2007.

Equity allocations are at their extreme, and that is a reason to have some caution or pause or at least think about rebalancing.

Benz: And those two time periods that you mentioned, things weren't so great in the period right after 2000 and 2007?

Kinniry: Right. And this is not a prediction of a bear market or a bubble, but what we do see is investors' flows with the market. It is very difficult for investors to rebalance, which is selling their winners and buying their losers. We don't know how long this bull market is going to last, but it has certainly elevated all investors' equity risk, and that's something they need to think about: Are they prepared if trouble hits?

Benz: When you think about bonds, as well, in terms of the bond preferences that investors seem to be expressing--they are buying some of the higher-risk stuff there, too, correct?

Kinniry: That would be the bigger concern, because the equity markets have lifted the equity allocations, but cash flows into bonds look much different than they did in the late '90s and even 2007. I always say, the bond market today, or what people are buying, is not your father's bond market. It's been high-yield corporates, it's been bank-loan notes, emerging-markets bonds.

So, they have "bonds" in the name, but they are actually out on the risk spectrum, which means if equities ever do fall into some trouble, the correlation, or the downside risk of the total portfolio, may be significantly worse than in past periods.

Benz: Let's talk about what investors should do. Say you're a well-meaning investor and you're trying to figure out the current market environment. You've got stocks--they're certainly not as cheap as they once were--as well as bonds, which aren't all that attractive in and of themselves given how low yields are, given that yields have a lot more room to move up than they do down. What should investors do? You mentioned rebalancing--is that still the prescription?

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