| NEW YORK, July 15
NEW YORK, July 15 Last month, Houston-based
financial adviser Gene Theobald picked up the phone and began
making calls to clients, telling them to expect a reality check
in their June account statement.
Theobald, who was the No. 2 bond salesman at Morgan Stanley
before moving to RBC Wealth Management
last year, estimates roughly 98 percent of his clients are
invested in fixed-income, with average portfolio allocations of
90 to 100 percent.
"Your next month's statement is going to look ugly,"
Theobald told many of more than 200 clients.
The downward spiral in the bond market, which for the past
few decades had long been considered a safer, more conservative
place to invest, has led to tough conversations with clients,
according to more than a dozen veteran financial advisers
interviewed by Reuters.
Customers who favor bonds tend to be on the conservative end
of the investing spectrum, so they are especially sensitive to
price declines. Advisers, on the other hand, find it
disconcerting that some of these investors are asking to
increase their equity holdings as a hedge against bonds.
"I'd hate to see clients hopping out of the frying pan into
the fire," said Michael Kitces, a financial adviser and
publisher of the popular financial planning industry blog Nerd's
Some advisers say they are reaching out to customers who are
heavily invested in bonds, reminding them that such fixed-income
assets remain less volatile than stocks, and if they are in
shorter-duration bonds, their portfolio may not even take a hit.
Duration measures a bond's sensitivity to interest-rate moves.
Other advisers who didn't contact clients before June
statements hit the mail are now hearing from anxious clients
worried about the impact of declining bond prices.
A SHORTER LEASH ON BONDS
In May and June, the bond market suffered its worst two
months period in a decade as prices for the 10-year tumbled amid
expectations that the U.S. Federal Reserve may begin to taper
its $85 billion monthly bond purchases as the U.S. economy
While investors added $257.8 billion to bond funds in 2012
and another $109.9 billion through the end of May, according to
Lipper, in June, there were unprecedented outflows of $40
The yield on 10-year Treasury notes climbed 46
basis points during May and rose another 36 basis points in
June, hitting a near two-year high of 2.75 percent in early July
on the back of a strong jobs report. On Tuesday, the 10-year
hovered around 2.54 percent, up roughly 42 basis points since
the end of May.
Yields move inversely to the price of bonds, so a sharp rise
in yields means a decline in prices.
"Even people that have bought bonds for 20 to 30 years of
their life still forget what happens when interest rates go up,"
said Tampa, Florida-based Greg Ghodsi, an adviser with Raymond
James Financial Inc.
Ghodsi, who said he has received more calls from clients
than usual over the past few months, is gradually moving his
them into shorter-duration bonds, which would have less of an
impact on a client's principal if interest rates rise.
"Anybody that has those long-term bonds is going to have a
little bit of shock, down 10 percent, down 15 percent," Ghodsi
said. "We have to slowly prepare clients for that volatility in
the marketplace that's going to happen if interest rates go
Ghodsi, whose clients have roughly 40 percent to 60 percent
of their assets in fixed-income, is shifting them into bonds
with average maturities of one to two years, from average
maturities of 10 years to 12 years back in 2010. He is also
cutting their bond allocations, replacing them with
dividend-paying stocks, such as regional banks or insurers.
Bank of America Corp's Merrill Lynch Private Banking
and Investment Group Chief Investment Officer Christopher Wolfe
said the firm is counseling advisers whose clients have
longer-term bond portfolios to rein in durations and shorten
maturities, at least over the next six to 12 months during what
he expects will be the biggest portion of the potential interest
Wolfe expects the yield on the 10-year Treasury to reach 3
percent by year end and 4 percent by the end of 2014. The yield
is currently hovering at 2.5 percent.
"You really may need to keep things on a much shorter leash
than you had in the past, meaning maturities of five years or
less," Wolfe said.
It is important to give clients some historical perspective,
"A bad bear market in stocks still loses way more money than
a bear market in bonds," Kitces said.
Drew Zager, head of a six-person team that runs $7.5 billion
in high-grade, fixed income for Morgan Stanley Private Wealth
Management in Los Angeles, said the fears about the bond
sell-off are overdone.
"It's not like investors are saying, 'OK, let me do the
math...and see if this makes sense.' They're just selling their
bond funds," Zager said, who runs money for sophisticated
investors, such as founders of bond funds and hedge funds.
Zager, whose minimum account size is $10 million, said
nearly all of his 87 clients are content with keeping the
current durations on their bond holdings. And some customers are
asking to extend duration a bit to take advantage of cheaper
prices. Some are moving from a 3.5-year duration to a 5-year
duration, while others are moving from a 5-year to a 7-year
duration. They don't have an appetite to go farther out than
that, and Zager doesn't recommend it.
Zager is concerned about bond funds, too. His advice if you
already own one is to hold on, because the sell off has gone too
far. Money will flow back into bond funds when people realize
this is an overreaction, but perhaps not for a month or two, he