Can Bonds Score a Repeat Performance After Big 2009?

Two recurring themes among analysts outside the preference for solid corporates are a tendency toward munis and away from Treasurys, which was one of the few classes for the year that saw a negative return. US debt had a negative 2.4 percent return after gaining 14 percent in 2008, according to data from Merrill and UBS.

"By mid-year the Fed is going to have to start increasing rates," said Roy Williams, CEO of Prestige Wealth Management in Pennington, N.J. "If I want to be in government, I'd rather be in TIPS than traditional government bonds. At least in that space you're not going to get walloped as much as interest rates go up."

Keep Your Windows Short

Williams echoes another theme: With economic uncertainty and government fiscal excess on the prowl, bond investors should keep a short window.

"We're keeping our duration at four years. We're probably going to compress that a little further down to about three years," he said. "Don't place bets right now. Have a tactically allocated portfolio."

Municipals, meanwhile, should provide return again even as large states like California find themselves in deep financial trouble.

"In the municipal world, you've got to look at how high rates can really go," Walsh said. "If the economy still isn't doing that well, I don't think you will see a huge jump in interest rates. You could still see some budget problems with municipalities, but I wouldn't we afraid."

UBS also said municipals will provide income, but "total return opportunities seem limited."

"We expect continued credit pressures on state and local governments issuers, less tax-exempt supply and looming increases in marginal rates to be key market drivers," the firm said. "This suggest a tug of war between weak credit fundamentals and supportive technicals."

Indeed, avoiding risk and protecting cash positions is likely to be a strong theme going forward into the new decade.

"Suffice it to say, we believe that the dominating focus will be on capital preservation and income orientation, whether that be in bonds, hybrids, hedge fund strategies, and a consistent focus on reliable dividend growth and dividend yield would seem to be in order," noted economist and market pessimist David Rosenberg, of Canada-based Gluskin Sheff, said in his year-ahead outlook.

"[O]ne conclusion I think we can agree on is the need to maintain defensive strategies and minimize volatility and downside risks as well as to focus on where the secular fundamentals are positive, such as fixed-income and in equity sectors that lever off the commodity sector," he added.

As always, investors should gauge risk by their own needs.

Prestige Wealth's Williams said his firm will stay with about a 45 percent portfolio allocation to bonds, while Walsh said investors will need to look closely at risk tolerance for the year ahead after such a wild ride in 2009.

"We look at it like everybody's different," Walsh said. "What is your objective? I think bonds should have been part of the portfolio in 2009 and I look forward to 2010."

Williams' outlook for further bond buying comes even though expectations are mostly lower for the group in the year ahead.

"The key driver of performance (in 2009) was a massive tightening in credit spreads, from historically wide levels that more than offset the rise in benchmark Treasury yields," UBS said. "Across the board, we generally believe bond returns are apt to be significantly lower in 2010."

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