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The Mad Rush Into Bonds

Courtesy of J P Morgan

Courtesy of J P Morgan

Have you ever seen a boat lean dangerously to one side after everyone rushed to that side to see something?

That is the feeling I have right now relative to bonds. Everyone is moving into higher yielding bonds and bond funds from the safety of lower yielding bank deposits. This scares me – whenever some asset class has everyone moving into it, that is generally the time that it is set to fall.

Above you can see that I have a graphic (courtesy of J P Morgan) that compares the amount of money that has moved into bond mutual funds to the amount of money that moved into technology mutual funds immediately prior to the NASDAQ Crash in 2000. You can see that more money has now moved into bonds than moved into technology funds.

Just like in 2000, my gut feeling says that there are a number of people that have moved money into high yield bonds in recent weeks so that they get an 8% yield but that they do not understand the risks associated with bonds, and junk bonds in particular. I am also betting they do not have anyone like BankChampaign that is looking out for them and trying to proactively manage the investment process on their behalf.

In recent days, we have been lowering our exposure to longer duration bond positions, corporate bond positions, and high yield bond positions. This is just a precautionary move that we feel is prudent given the big move by the unsuspecting populous into an asset class they do not understand. When investing in bonds, your risks are primarily Interest Rate Risk and Credit Risk. If you are invested in government bonds, theoretically, you have no credit risk, just interest rate risk. In corporate bonds, you have both interest rate risk and credit risk. In high yield bonds, you also have both interest rate risk and credit risk (including a higher risk of default), but you also add in the fact that high yield bonds react to the movements of the stock market in addition to the movements of the bond market. This makes it a much more complex investment.

As you review your statements for this reporting period and over coming reporting periods, you are likely to see that we will continue to make incremental moves into shorter duration fixed income positions and treasury inflation protection bond positions in order to protect the principal of our clients’ investment portfolios.

Bonds are not CD’s, and I think there are lots of people out there about to find this out.

Mark