|S&P 500 Index*||1.80%||1.30%||2.60%||Large-cap stocks|
|Nasdaq Comp.*||2.98%||2.65%||2.22%||Large-cap tech stocks|
|Russell 1000 Growth||1.25%||1.94%||2.74%||Large-cap growth stocks|
|Russell 1000 Value||2.36%||0.88%||3.94%||Large-cap value stocks|
|Russell 2000 Growth||3.33%||0.09%||5.68%||Small-cap growth stocks|
|Russell 2000 Value||5.08%||0.85%||7.83%||Small-cap value stocks|
|EAFE||2.23%||0.44%||4.86%||Europe, Australasia & Far East Index|
|Lehman Aggregate||0.57%||-2.44%||0.15%||U.S. Government Bonds|
|Lehman High Yield||1.43%||-0.96%||1.36%||High Yield Corporate Bonds|
|Calyon Financial Barclay Index**||-2.51%||-7.28%||-3.92%||Managed Futures|
|3-month Treasury Bill||0.43%|
|All returns are estimates as of 06/30/2004.|
|*Return numbers do not include dividends.|
|** Returns as of 06/29/2004.|
With the markets officially in a rising rate mode, a plethora of investment advisors are likely fielding the same question from investors: “Why should I own bonds?”
There’s little doubt that rates are poised to increase, but that does not necessarily mean that the total return of fixed-income securities will head straight down. If that were the case, I wouldn’t just sell bonds, I’d short-sell them.
The most compelling reason for including bonds in a portfolio is diversification. Consider the 1970s, a decade when interest rates increased from 5% to 14%. According to a recent Ibbotson study, an investor with a 30% allocation to bonds during this period captured 98% of the total return of stocks with only 73% of the price volatility.
If that statistic isn’t convincing enough, consider the possibility of another market shock, be it a stock market crash a la 1987, or another terrorist attack on U.S. soil. In the past, bonds acted as a shock absorber during such tumultuous events, cushioning the bruising performance of equities.
Even so, a checkup on the fixed-income portion of clients’ portfolios is certainly in order. When it comes to bonds, efficient-market aficionados have long prescribed a mix of short-duration, high-quality issues, a mix that makes for a great anchor. A cheap way to capture the low end of the yield curve is by purchasing an exchange traded fund like the iShares Lehman 1-3 Year Treasury Bond (SHY). I also advocate a bit of high yield, since credit spreads seem to perform well during periods of rising rates. In the interim, we’re avoiding mortgage debt, with the concern that a sudden increase in rates may lead to convexity-induced selling.
Regardless of economic conditions, bonds should be a part of every long-term investor’s holdings. It is prudent, however, to adjust duration and credit spread exposure as conditions change.
Contact Robert F. Keane with questions or comments at: