Today’s (i.e., Thursday, 5/2/13’s, page C1) Wall Street Journal reports that 352 funds Morningstar classifies as bond funds hold stocks and, in some cases, not just a few stocks. Some bond funds hold place 10% to 25% of their assets in stocks; one small fund, Forward Income Builder Fund, holds “nearly 49%” of its assets in stocks. Interestingly, or troublingly, if the latter were a word, the article does not specify how much of these large stock holdings are comprised of preferred stocks, which would be much more in keeping with a typical bond fund’s goal and mission, rather than common stocks, which are a far longer walk off the straight and narrow path. Nonetheless, the percentage of bond funds investing in stocks is increasing and the portion of their assets being invested in stocks is rising as well.
The reason for this shift into bonds is obvious; there isn’t much yield anywhere in the bond market as Ben Bernanke has proven relentless in his war on savers, and especially on elderly savers. So bond fund managers, as well as individual investors (See my 4/29/13 post, YEAH, THE BIG DIVIDEND PAYERS ARE GETTING RICH, BUT…, and my 4/16/13 musings, S&P YIELDS VS. BOND YIELDS: I’M YOUR MAN WHEN IT COMES TO STATING THE OBVIOUS.) are buying stocks that pay big dividends as, in their minds, near bond substitutes. Yours truly understands the search for income and the frustration of being unable to find it in the fixed income markets. But I do suspect that this reaching for yield will lead to a bad end.
Regardless of what yours truly thinks, however, this substitution of big dividend payers for bonds strategy has worked…so far. Indeed, the aforementioned Forward Income Builder Fund, which holds “nearly 49%” of its assets in stocks, sports a year to date performance in the top 4% of its peer group. Congratulations to Nathan Rowader (whom I don’t know) and the team at Forward; I know from personal experience how good it feels to be at the top of one’s performance peer group.
Good performance, however, does not equal prudent investment management.
When I invest in a bond fund, I want the fund to be invested in bonds. Even though its prospectus, and fuzzy SEC regulations, may allow it to fudge on its portfolio and buy some stocks, I, as an investor, want bonds when I invest in bonds. You should, too. I don’t care if the manager thinks bonds are rich; I hired him/her/them to invest in bonds, not to make asset allocation decisions. If I think bonds are rich at a particular point in time, as I do now, I will make my own asset allocation decision and take some of my money out of bond funds and put it into stock funds. You should, too.
All this contributes to my huge but always growing conviction that index funds are the only way to go. Not only do they keep costs down and avoid the type of manager risk that this post discusses, but they maintain style purity, if you will, or at least a heck of a lot more style purity than most actively managed funds. If I buy a bond market index fund, I know I’m buying bonds. I don’t have to run the risk that some hot shot manager (who may well be at least twenty years my junior) deciding that the money I want in bonds ought to be in stocks because s/he thinks stocks generate more income, are cheaper, etc. That s/he may get lucky in that prognostication is of little or no comfort to me. Similarly, if I buy a stock index fund, I know I’m buying stocks, not holding a lot of cash because the manager thinks stocks are rich. If I thought stocks were rich, I’d move some money out of stocks myself.
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