Taking A Cautious Approach To Riding The Recovery
There’s no question, investors were devastated by losses from the market meltdown, but with many analysts saying the economic recovery is finally beginning to take shape, now is the time for investors to reevaluate their fixed income and equity investments to take full advantage of opportunities ahead.
For some investors "there still is a case of once bitten, twice shy,” says Paul Zemsky, head of the Multi-Asset Strategies and Solutions Group at ING Investment Management. "We do see a reluctance of people to get back in the market and people are tending to buy certainty of cash flow over uncertainty of equities."
If that describes you, here's some things to consider in weighing your fixed income and equities options.
Heavy flows into bond funds, particularly government-backed Treasurys, shows this is a popular strategy, but the rewards are wearing thin.
However, he adds that "the cost of certainty has become very high with interest rates effectively at zero, the returns offered by Treasurys are not enough to live on.”
“Unless you can’t afford to lose a dime do not allocate a disproportionate amount of assets to this area,” says Zemsky.
John Diehl, a certified financial planner and senior vice president at Hartford Investment and Retirement Division adds, “There is still a lot of money going into bond funds, but what I would question is, what kind of fixed income are we buying.”
According to Diehl, if you are 90 percent invested in Treasury bonds, you need to ask yourself whether that is intentional and whether it is appropriate today.
For most, the answer to the second question is no. So what fixed income investments should you be considering at this time?
Tim Knepp, chief investment officer of Genworth Financial Asset Management, who maintains a fairly conservative view of the market says, “We have a fairly defensive view of interest rates so we won’t buy long term bonds because they are more sensitive to interest rates.”
What he does like are convertible bonds and shorter maturity, investment grade bonds.
“If you’re looking at high quality, shorter maturity fixed income, even a conservative account could have upwards of 40 percent allocated toward fixed income and not be overly concerned with credit or interest rates picking up,” says Knepp.
Knepp would also shy away from high yield bonds as he believes “a lot of that gain has already been played.” However, he says, if investors are interested in playing high yield they should look for funds that are conservatively managed in that space
Not everyone is in agreement on the high yield arena. ING’s Zemsky believes that diversified high yield bonds could be an option for investors. Yields are close to 10 percent and defaults should be less than 2 percent, so that area is pretty attractive, he says.
For many investors, the best bet for their fixed income exposure is to buy a diversified bond ETF or mutual fund, as they will spread risk in different areas. How much each investor should allocate toward fixed income depends on their individual tolerance for risk.
Where equities come into play, largely depends on how far along you believe the recovery has progressed.
Zemsky, who believes the economy has been in recovery mode since the first quarter, says, “While there is still negativity out there… We think leaning against the skepticism is the right thing to do," and thus recommends being modestly overweight in equities.
He believes large cap equities in particularly will fare well in the recovery.
Knepp on the other hand, isn’t quite so optimistic, even though he says the economy is on the verge of recovery.
“We are not bullish by any means and we would look for more conservative exposures on equities for people that want to get back into the market.
For instance, Knepp believes investors should shy away from companies overly exposed to discretionary spending, even though to date that sector has done pretty well.
“We would look more at defensive sectors like health care and staples,” he says, adding that more cyclical areas such as financials and other economically sensitive businesses, may also fare well simply because they were beaten down so heavily in 2008.
In addition he said that investors who have been looking toward bonds for income might instead want to consider stocks for dividend income. Some dividend paying sectors that he likes include health care and consumer staples (both defensive plays, as well) and even technology and telecom.
“These companies and sectors provide essential services and have pricing power,” he explains
Diehl agrees that dividend-paying stocks are a good bet for the recovery.
“People are looking for some dividend yield,” Diehl says, adding that dividend-paying companies generally tend to be more stable.
Diehl also says that coming into a recovery period, small- and mid- cap stocks also have a tendency to shine, though he warns investors that while the groups they may be attractive, one should not be overweight in them.
If you are considering giving your asset allocation a face-lift, Diehl suggests doing so gradually.
“The key is knowing that your don’t have to get there overnight,” says Diehl. Investors should “start diversifying small portions into new asset classes” and continue to do so over a six- to 12-month period.