What Happened to Bonds

Remember “Boring is Beautiful?” Well some bond funds aren’t.

Last year the Barclay’s Aggregate Bond Index returned 7.5%. That’s pretty good considering the S&P lost 37% last year and global markets lost over 40%. The problem is, your average bond fund lost money. Heck, even Bill Gross, Master of the Universe, only earned 3.5%. What happened?

Bond funds started enhancing returns over 25 years ago, starting with “fallen angel” debt-good companies whose ratings temporarily no longer make the grade-and ending with credit default swaps and emerging market bonds. In between you even had bond fund managers buying utility stocks and claiming that their steady dividends made them fixed income securities. When did bond managers become equity gurus?

For years, this seemed to work out well, as core-plus bond funds regularly beat their benchmark by half a percent or more. Until 2008.

Last year, the bill came due. All that complex structure, implicit leverage, and out-of-the-money options hit the fan, and a couple decade’s worth of outperformance disappeared into the maw of the global credit crunch. Over the past ten years, now, your average bond fund underperformed the Aggregate Index.

The lesson? There’s no such thing as a free lunch. And when you have a bond investment, make sure that your manager is buying bonds.

Douglas R. Tengdin, CFA
Chief Investment Officer
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