June 7, 2002 — “What have you done for me lately,” seems to sum up the views about bonds for several money managers and financial professionals.
The flip side of the bear market for stocks in recent years has been healthy gains for bonds in general. The Lehman Aggregate Bond Index, a widely followed barometer of the bond market, rose an annualized 6.3% over the three-year period 1999 through 2001, while the S&P 500 fell 1.02% annualized. Despite bonds’ recent gains, professional managers appear to be unmoved from the consensus that stocks offer the best prospects for capital appreciation over the long term.
“Bond outperformance is not sustainable — it reflects big declines in interest rates,” notes Al Kugel, senior investment strategist at Stein Roe. Rather than signaling a major change, Kugel believes fixed-income gains indicate a healthy correction following unsustainable rises in stocks. “The past two and one-half years are bringing the markets down to long-term averages,” Kugel says.
Perhaps it’s time to consider rebalancing. Hank Herrmann, chief investment officer of Waddell & Reed, thinks investors should take a closer look at bonds. In light of outsized equity gains in the 1990s bull market, Herrmann suggests that his firm’s clients reconsider their stock positions. “The public is overweighted in equities because of the equity cult of the 1990s,” Herrmann claims.
Overall returns for stocks and bonds may be fairly similar in the next few years, Herrmann projects. He thinks stocks are currently priced for 6% to 7% gains, and quality corporate bonds are pegged for gains of close to 6%.
People may be less diversified following a 10-year bull market, says Chris Brown, manager of Pax World Balanced Fund (PAXWX), but the heavy exposure to stocks may not be bad. For the fund he manages, Brown is “down to a minimum” allocation for bonds, currently 25.6%. Brown says he’s bearish on bonds because stocks historically outperform bonds.
“Bonds are a lousy investment because of their long-term exposure,” says Bruce Bent, president of Reserve Funds, adding “I’ve never owned a bond in my life, and I started out as a credit analyst.” While Bent is “not the least bit optimistic” about the stock market for this year and next, he cautions that investors who favor bonds will “miss out on the upturn in stocks” in the near term.
Although “there are risks embedded in stocks and bonds,” Oscar Gonzalez, an economist with John Hancock Financial Services, advises against “putting all your investments on one side.” Gonzalez recommends a very-traditional 60% weighting in stocks and 40% in bonds — “one of the better mixes for stability and long-term returns.”
When considering asset allocation, Mike Holland, manager of Holland Balanced Fund (HOLBX), believes investors should focus on their overall financial assets, including homes, annuities, and pension plans. Taking this wider view, individuals may have broader exposure to fixed-income investments than they realize, according to Holland, since annuities and pensions often have sizeable fixed-income components. Holland also feels that money-market holdings “somewhat meet the need for fixed-income” in the average portfolio. To those who believe that investors do not have enough exposure to fixed-income assets, Holland would reply that “individuals are pretty darn savvy, if you look at money-market funds and homes.”
Stein Roe’s Kugel advises that investors who want to hold bonds should consider shorter-term issues. “I wouldn’t be enthused about long-term bonds,” says Kugel, because of the likelihood of higher interest rates.