Will there be a herd mentality to “sell bonds” causing bond funds to suffer more than balanced funds?

21 01 2011

As with any financial market or product there is the possibility that investors will “sell bonds” as a herd, but there are a few things to consider.

First thing to think about is – what are balanced funds?  Many “balanced” funds are made up of a few different bond and equity funds, the blend depending on their ultimate goal and risk.  Others invest directly in stocks and bonds to create their portfolio.  What that means is that while they do hold some bonds in their portfolio, they also own equities, and since these asset classes don’t typically move together, balanced fund portfolios will most likely suffer less than a bond-only fund if there were a hard bond sell-off.

In the event of a bond sell-off, it can be helpful to picture where in the market the moeny that is currently in bonds would be reinvested.  Is it likely the “herd” is moving into cash, into equities, or into another asset class?  If you believe that the money from the bonds is moving to equities, then balanced funds will almost certainly perform better in this situation.

Additionally, it is important to consider what kind of bonds are suffering the sell-off.   The behavior of municipal bonds, for example,  is very different than the behavior of high yield bonds; the behavior of long term bonds is generally very different than that of short term bonds.  It is similar to trying to discern if stocks will suffer- without knowing if you are talking about emerging markets, developed foreign markets,  or US stocks. Each will behave differently under different interest rates, currency valuations, and economic conditions.

As with equities, you need to have a firm understanding of why you are holding any particular bond investment.  If you are looking for extreme safety of principal,  then most investors would hold short duration, high quality bonds; but but at the expense of a competitive yield.  If you are looking for a higher yield in bonds, in the current market environment you are going to have to take some additional risk to your principal to get it.  Whether that risk is best taken by holding a longer term bond (more interest rate sensitivity), or a lower quality bond (higher risk of default), typically seems to be an individual preference.

The ultimate answer for most investors is to find a mix of assets that you are comfortable with and stick with them.  If there is one thing the markets have proven time and time again, it’s that the patient, well diversified, properly allocated investor will typically fare better over the long run than the investor who is constantly making changes to his investments based on daily news and the “hot pick.”

Information in this article does not constitute a recommendation or solicitation for any product mentioned.  Mutual funds may only be sold by prospectus.  Past performance is no guarantee of future performance.  Consult your financial advisor for specific recommendations.

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2 responses

6 02 2015
Thinking About Ultra Short Duration Bond Funds For Safety | bond-funds

[…] WILL THERE BE A HERD MENTALITY TO “”SELL BONDS”” CAUSING […]

1 03 2011
Zoe

this is very interesting! thanks for sharing

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