Bond ETF Investors Overconfident After 30-Year Rally?

January 9th at 9:52am by John Spence

Bill McNabb, chief executive of mutual fund and ETF giant Vanguard, is worried about what could happen to bond investors if yields finally start to rise from rock-bottom levels.

“You could argue it’s almost as extreme as stocks were in 1999,” the Vanguard CEO tells Investment News.

The iShares Barclays 20+ Year Treasury Bond (NYSEArca: TLT) has an annualized return of 14% the past three years to outperform U.S. stocks.

Bonds have enjoyed a bull run of more than three decades and yields have been pushed to near record lows in the aftermath of the financial crisis. However, rising interest rates would eat into bond prices and punish investors who have piled into fixed-income funds and ETFs.

McNabb isn’t predicting that bond funds will suffer the same fate as stocks experienced after the dot-com crash over the next 10 years, but he is warning clients that they need to reduce their expectations, according to the Investment News story.

“It’s always dangerous to predict returns, but the probability of bonds having the same return over the next 10 years as the last 10 is almost zero,” he said, while pointing out that investors shouldn’t totally abandon bonds since they can diversify an equity portfolio.

Treasury yields have pulled back somewhat this week after U.S. government debt was off to its worst start to a year since 2009. Bond yields and prices move in opposite directions. [Inverse Treasury ETFs Rally]

“The most important investment question of 2013 is ‘When will the great bond rally finally end?’” writes Nicholas Colas, ConvergEx Group chief market strategist, in a note Wednesday.

“Thirty-plus years of generally positive returns is an impressive record, after all. But it also engenders a lot of self-confidence in the minds of those investors who have seen their bond portfolios handily trounce stocks over the last decade and ‘Alternative’ assets such as gold for decades,” the strategist added. “Think a little pullback is going to shake this crowd?  Think again.” [Will the Bond ETF Bubble Burst in 2013?]

Indeed, investors for years have heard warnings that yields could rise and inflict damage on bond funds and ETFs. It hasn’t happened yet.

Yields on the 10-year Treasury note fell back under 1.9% on Wednesday after dropping below 1.6% in late 2012.

“Brighter economic prospects, diminishing fears about a U.S. fiscal crisis and the idea that the beginning of the end is in sight for a period of ultra-easy monetary policy have sent government bond yields racing higher at the start of the year,” CNBC.com reported Wednesday.

“The main reason for rising yields is that Treasurys’ role as a safe-haven asset is declining and the economy is moving inexorably towards the first rate hike,” David Keeble, global head of interest rate strategy at Credit Agricole, said in the story. “Not only do we believe that the low point in Treasury yields has been hit but also that implied and actual volatilities will begin to ascend.”

Full disclosure: Tom Lydon’s clients own TLT.

The opinions and forecasts expressed herein are solely those of John Spence, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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