Media Scare Tactics: The Coming ‘Bond Bubble’

Is the media scaring you about the so-called coming ‘Bond Bubble’? Block out the noise and focus on what matters: asset allocation.

With all the hoopla going on about fixed income being the possible next “bubble”, I thought it prudent to talk about asset allocation. Fixed income is just one part of a well-balanced portfolio. At DWM, we believe in multiple asset classes including traditional asset classes like fixed income and equities, along with alternatives.

You do not want to all-out avoid or shun an asset class. We’ve seen people that have been out of equities since 2008 and they’ve missed one of the biggest bull markets in history.

You also do not want to load up in just one asset class. We saw people that were in 100% stocks going into 2008 that felt the full pain of a 35-50% drop. That’s a deep hole to dig out of.

The key is balance. A case can be made that everyone should have about at a minimum 20% allocated to each asset class. So how does one determine what percentage of equities, stocks, and alternatives their portfolio should have? DWM does this by identifying your goals, risk tolerance, return objectives, income needs, time horizon, and other special requirements. As every client is unique, so is each client portfolio. A younger client with a high risk tolerance may be 50% equities / 20% fixed / 30% alternatives. An older client with low risk tolerance may be 20% equities / 50% fixed / 30% alternatives.

Take a look at the graphic below which shows a sample individual investor portfolio versus an institutional portfolio from 2009:

pie charts 061313

You can see that institutions have the majority of their assets allocated to alternatives. And because of it, they have had pretty good success. The individual investor is just starting to catch up, as access (or rather the previous lack thereof) to alternatives has changed. Until the last several years, only institutions and the extremely wealthy had access to alternatives. Furthermore, there were high minimums, lock-up periods, bad transparency, and high expenses that were not practical for the individual investor. But that is really changing. We at DWM have been using liquid alternatives for the last several years. More and more of these liquid alts come available almost every day.

In a time and age where the 30 year bond bull market may be coming to an end and a time when the equity market is being called “overheated”, alternatives may offer a complementing asset class that can give your portfolio better overall risk-adjusted returns. Alts can play many different roles in a portfolio from return enhancer to fixed income substitute to diversifier. They can provide investors insurance against declines to the traditional 60 / 40 model. They can mitigate downside risk and lower volatility.

Now, don’t get me wrong: there is no silver bullet. Not all alternatives are created equal, and not all are going to be consistent winners. But with a diversified portfolio consisting of all asset classes, you should have a much smoother, consistent ride which can ultimately lead you to better financial success.