Bond returns may be negative for the next decade, so investors need to lower their return expectations.
This will be hardest for long-time bond investors since they started using the vehicles when there were double-digit interest rates, says Barry Morrison, CEO of Aston Hill Institutional Partners.
Twenty-five or 30 years ago, he adds, clients were holding 70% to 75% of their portfolios in government bonds, with returns being driven by double-digit interest rates. The rest of their assets were invested in domestic and international equities.
Now, advisors have to help people understand that bond “returns are probably going to be…very small for [the next] five to 10 years as interest rates rise,” says Morrison. There’s a silver lining, though, since fixed-income portfolios could still perform well if invested in corporate bonds that generate dividend income.
An active approach
It helps if clients’ fixed-income portfolios are actively managed. The only challenge, says Morrison, is people have to account for management fees and compare portfolio managers’ track records.
When choosing active management, people should seek managers who’ve overseen the same funds for several years, he suggests. Also, those who’ve produced solid returns and low volatility levels.
And it doesn’t matter if managers have beaten the market, says Morrison, since that’s hard to accomplish. For example, over the [past] 200 years, the [U.S.] stock market has been up [about] 8%…If you look at [managers’] track records, only about 30% are able beat the market.”
You can suggest active management “whether [a client is] 25 or 75 years old,” says Morrison. “We have clients in their 80s [who]…have…no bonds in their portfolios [since we’ve] reminded them [they] can’t get 10%-plus interest rates on bonds.”
In most cases, though, you can safely place half of a client’s portfolio in bonds that offer dividend income. The remaining half should then tap into well managed, diversified equity funds.