Morningstar Advisor - June/July 2010 - 9

Letter From the Editor

Bonds’ Glow Fades
Hit with huge losses in 2008, mutual-fund investors have been placing their assets into fixed-income funds in record amounts. It’s an understandable reaction. Investors were reawakened to the fact that investing in the stock market is risky—that markets don’t always go up, even over the long periods of time, and that equity prices are volatile. That bond indexes handedly outperformed stock indexes over the decade only hammered home the point. Bonds might be boring, but after 2008, boring is where many investors want to be. Of course, investors specialize in fighting last year’s battles. The factors that made bonds attractive investments before and during the financial crisis are disappearing. Although investors may have had legitimate reasons to have dialed down their stock allocations in favor of fixed income, piling into bonds and counting on them to keep up their staid, winning ways has the look and feel of a classic case of bad investor timing. Veteran Morningstar fixed-income analyst Miriam Sjoblom is very concerned. In this issue’s Spotlight (“The Game Is Up,” Page 30), she argues that bond investors are in a very tight spot. Income is a problem because of low yield levels, and price appreciation would become price depreciation if (or when?) interest rates rise. Sjoblom reports that bond-fund managers are wrestling with what to do, too. Those managers who are uncertain about the economy’s recovery (she calls this camp “The Gross,” after the PIMCO manager) are trading credit risk for other risks, such as interest-rate risk. Those who are more confident about the economy (“The Fuss” camp, named after the Loomis Sayles manager) are essentially doing the opposite—taking credit risk over interest-rate risk. Both approaches have merits. Which camp is right remains to be seen, but the important point today is that advisors should be aware of the trade-offs that their clients’ bond managers are making. Are they in The Gross camp or The Fuss camp? If the bond markets do become more volatile, opportunities may arise for “bond-pickers” of individual issues. In our poll in On Topic (Page 10), 60% of advisors say their clients invest in individual bonds. Morningstar’s equity research group recently started rating the credit quality of companies that issue bonds. The team is also judging whether individual issues are good investments. In Spotlight, Haywood Kelly, who leads the research group, unveils a handful of bonds that are offering good yields relative to their credit risk (“Bonds We Like,” Page 37). It’s an exciting new area for Morningstar that will help investors make better bond investments. In the April/May issue (“Markowitz 2.0”), Stanford professor Sam Savage and Morningstar researcher Paul D. Kaplan wrote about their new scenario-based approach to mean-variance optimization. They portrayed their work as bringing MVO into the 21st century. We wondered what the inventor of portfolio optimization thought of their effort, so we invited Nobel Prize winner Harry Markowitz to join the Savage and Kaplan for a Morningstar Conversation (“What Does Harry Markowitz Think?” Page 43). Markowitz was complimentary, but was especially fond of the name of a tool Savage built to show how the model works. “How can I refuse anything to a man who has named an important contribution the Markowitzatron.” Finally, we made some changes to the Investments a la Carte section (“Four Picks for the Present,” Page 57). We changed the section’s layout, and the graphics for each pick present more-relevant information. Let us know what you think at magazine_editor@ morningstar.com.

Jerry Kerns

MorningstarAdvisor.com

http://www.MorningstarAdvisor.com

Morningstar Advisor - June/July 2010

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