In today’s bond market, finding yield is up there with spying Bigfoot or the Loch Ness Monster. However, yields shouldn’t be the primary drivers when investors are looking to build out their bond portfolios.
Furthermore, yields shouldn’t be the main determinant on how much risk to take on.
“Well, I think the most important thing is that you shouldn’t let a yield target determine how much risk to take with your bond portfolio,” said Alex Bryan, Morningstar’s director of passive strategies research in North America. “Your comfort with losses and ability to absorb them should be the main driver of how much risk you take with the bond portfolio that you have. Your goals will also influence what type of bond solution is appropriate for you. So, if your main goal is to diversify stock risk or keep money in a safe place that you may need in a couple of years, it may be prudent to focus on more-conservative bond portfolios that invest in higher-quality bonds.”
Bryan mentions that an investor’s penchant for risk and goals should also be factors when building a bond portfolio.
“If your goal is to maximize risk-adjusted performance for money that you don’t need for a long time, it may be appropriate to take on a little bit more risk to earn higher returns over the long term,” Bryan added. “So, really, it’s a personal decision about what your risk tolerance is and what your goals for your bond portfolio are.”
In order to remain competitive while yields are at bottom-barrel levels, funds may be looking to up their fees while at the same time, take on more risk to cover those fees. It’s something investors need to be wary of in their quest for yield.
“ So, when you’re in a low-rate environment, as we are today, fees are even more important than they normally are,” said Bryan. “And they are always important. But with yields being as low as they are, it’s very difficult for managers who are charging high fees to recoup those fees. So, oftentimes, managers who are charging higher fees will tend to take on more risk to recoup those fees. Now, sometimes that pays off, but sometimes it doesn’t. And that risk is always there. So, it’s important to pay close attention to fees not only because it’s one of the best predictors of performance but also because managers that are charging high fees might be tempted to take on more risk in order to recoup the fees that they’re charging.”
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