Predicting the Predictable
By: Brian Evans, CPA/PFS, portfolio manager of the AdvisorShares Madrona ETFs (FWDB, FWDD & FWDI), owner of Madrona Financial Services and Bauer Evans, CPAs
Did you know the value of the global bond market exceeds the value of the global public equities market? That’s right, bonds trump stocks in total value yet most of the press is focused on the sexier stock market. It’s for this reason that bonds should begin the discussion for what to look for in the 4th quarter of 2014. The biggest concern will be the tapering of bond purchases by the Fed and what that will do to broad market bond funds and targeted bond funds.
Most passive bond market indexes own a significant overweight to US Treasury and agency debt. They obtain this overweight by virtually eliminating US high yield, preferred bonds, convertibles, emerging market sovereign and corporate debt, and international high yield bonds. The Treasury and agency sectors are the very two areas at highest risk of loss of principal when they lose the artificial demand from the Fed.
Think of it, when the Treasury loses its biggest customer, it still has to attract investors for its voracious supply of new borrowing. To do so, it will have to offer higher rates on bond offerings. Investors with very little yield already will see their principal suffer, motivating them to sell and redeploy. It is unlikely this redeployment of investment dollars will be towards equities or money markets. The shift will most likely be towards the strong corporate bond markets and even into higher yielding emerging market bonds of all types, along with select preferred bonds and global high yields.
Being positioned to where bond investment flows are headed, rather than owning where investment is flowing from, will likely be the most important determining factor for bond investor returns in the upcoming months. The fourth quarter outlook for market cap bond indexes is poor. You don’t want to be the person who knew that Treasury and agency debt were at risk, were able to predict the upcoming scenario, owned market cap bond indexes loaded with these bond holdings, and yet did nothing to protect your portfolio, or the portfolios of your advisory clients.