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Portfolio > Portfolio Construction

3 Investments Retirees Should Avoid: Morningstar’s Benz

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Most retirees don’t want to spend much of their time stressing over their portfolios. And, even if they’re working with an advisor, they may not benefit much from certain investments that can have extra costs and complex strategies.

These realities, says Christine Benz, Morningstar’s director of personal finance, mean those in retirement should generally avoid three investment categories, which she highlighted in a recent televised interview.

“You will maybe hold some of those investment types within more broadly diversified funds,” she explained, “but you’re not holding them as standalone offerings. They’ll just tend to provide you a little more peace of mind.”

Foreign Currency Bonds

Though they can benefit investors in the accumulation phase of life, these holdings are volatile.

“The reason is that you hold bonds to act differently than your equity portfolio — when, in fact, foreign-currency-denominated bonds tend to have a lot more volatility than, say, core U.S.-dollar-denominated bonds,” Benz explained, pointing to research conducted by Ibbotson Associates. “So, you want to be careful before adding foreign-currency-denominated bonds.”

PIMCO’s hedged Foreign Bond Fund (PFOAX), for instance, is less volatile than the non-hedged sister product (PFUAX). “It has had a standard deviation of 4 over the past decade vs. 9 for the unhedged version. So, that’s a huge difference in volatility,” she noted.

Retired investors could own some foreign-currency-denominated bonds inside broadly diversified products, like the Loomis Sayles Bond Fund (LSBRX). “But I think that dedicated foreign-currency-denominated bond fund probably isn’t a necessity for most retiree portfolios,” Benz stressed.

Emerging Markets Funds

This is another category with volatility issues.

“When you look at the standard deviation, 4 in an emerging-markets fund relative to a foreign-stock fund, you see at least somewhat higher volatility,” Benz explained, “not quite as high as we saw with the hedged- vs. unhedged-bond portfolios. But you still do see a volatility discrepancy.”

There’s also the issue of duplicity.

“These days, most broadly diversified foreign-stock funds do have a healthy share of their portfolios in emerging markets — anywhere from 10% to 20%. So, take a look at what you have already before layering on an additional emerging-markets fund,” the fund expert said.

In addition, these funds can be costly.

“If you go out and buy a dedicated EM fund, typically you’re going to pay a higher price tag for it,” Benz said. “Some of the index products are pretty reasonably priced; but certainly if you’re looking at any sort of actively managed product, it will generally cost more than a broadly diversified foreign-stock fund.”

Alternative Products

A sizeable flow of assets has gone into this category over the past few years. For instance, assets in ETF-based alternative products jumped by over $60 million the first quarter to hit $368.1 million, Morningstar says.

However, if investors already have core equity and core fixed income exposure, alternative funds may not give them much diversification.

“If you’re looking at categories like long/short equity, for example — and that’s one of the categories where we’ve seen a lot of the inflows — what you tend to see is a performance pattern that falls somewhere between the stock and bond markets but much higher costs,” Benz said.

Plus, these funds can have expense ratios of 2% and up.

“So, you’re looking at returns that fall in the neighborhood of maybe 8% over the past five years but 2% expense ratios,” she noted. “That’s a really high percentage of your return that you’re ceding to expenses. I just think that the value proposition—certainly when you look across the whole category of alternatives … just isn’t there for retirees.

Upsides of Simplification

Leaving alternative, emerging-market and foreign-bond holdings out of portfolios can help retirees in other ways, too, the Morningstar executive says.

Some investors may want to own portfolios that their spouse can easily oversee. “That’s another key advantage to reducing the number of holdings,” Benz added.

Overall, the key advantage in avoiding these three investment categories is that is should “reduce the angst associated with your portfolio,” she says. “If you don’t have these holdings that have extreme highs and lows, you will just have less hand-wringing over that portfolio.”

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