With U.S. stocks likely to generate subpar returns over the next 10 years, now is a good time to focus on bonds to provide ballast for your clients’ portfolios, said Greg Davis, Vanguard’s chief investment officer for much of its fixed income and equity areas.
Bonds can help your clients withstand the rampant volatility that the stock market has experienced since October, Davis said at the Inside ETFs conference in Hollywood, Fla. And you can help your clients navigate the rough waters, he said. “You can provide value as an investment expert and behavioral coach.”
He compared what you and your clients are going through to the travails of the boxer Rocky, played by Sylvester Stallone, in the movies.
“Even when he wins, he takes a beating along the way,” Davis said. Vanguard expects growth of just 2 percent in the U.S. this year, with inflation also around 2 percent. While its economists don’t anticipate a recession this year, they have raised the odds to 35 percent from 30 percent last year. And they see a 40 to 50 percent chance of recession next year.
Vanguard expects one rate hike by the Federal Reserve this year—in June. And volatility won’t go away. The firm predicts stocks will generate annualized returns of just 5 percent over the next 10 years. “That’s why your role as a behavioral coach is exceedingly important,” Davis said. “An advisor can add 150 basis points to a portfolio, just by helping clients stick to their plans.”
Now is the time to look at bonds for their “ballast and returns,” he said, calling bonds a “powerful diversifier” that helps hedge against stock market downturns. For the past 30 years, bonds have helped counter the losses in stocks. When equities plummeted in the fourth quarter last year, bonds rose, Davis pointed out.
And counter to conventional wisdom, bond funds are even a good investment in times of rising interest rates, as long as you hold the funds for longer than their duration, Davis said. That’s because once bonds mature in that environment, the new bonds purchased will have higher yields.
In the current backdrop of a flat yield curve, cash and short-duration high-quality bonds provide attractive returns, Davis noted.
Cost and credit risk are important factors to take into account when considering bond funds, he said. As for costs, “most of the value of managers disappears when you take fees into account,” Davis said. And that’s particularly important in a low-return environment. “Choosing funds isn’t easy, but low costs increase your chance for success.”
As for risk, “some bond managers are chasing yield to generate more return,” he said. And that can be a problem. It lessens the bonds’ ballast for a portfolio.
He said Vanguard is positioned defensively, as it expects yield-curve steepening near the end of the Fed’s tightening cycle. “We see darker clouds, including slower growth, and that’s negative for credit.”
Be careful about pushing too far in the defensive part of client portfolios, Davis said. “Many investors may expect higher returns than markets can deliver. This is where you provide fundamental value.”