If investors' flight> from safety to risk wasn't evident enough in the stunning returns posted by emerging markets, tech stocks and financials since the market bottomed in early March, just take a look at the corporate bond market. It's going gangbusters, too.
The exchange-traded fund, a proxy for debt issued by companies with high credit ratings, has gained 11% since the March trough. But that's nothing compared to the high-risk junk bond market. Bonds of companies with less-than-stellar credit quality -- as measured by the SPDR Barclays Capital High Yield Bond ETF (JNK)
Returns like that are enough to make any bond investor salivate (and they serve as a nice illustration of what a herd looks like when it's chasing yield). But as debt buyers look to the second half of the year, it's apparent that the days of really big returns are over.
The recent boom in bonds is a classic shift from safety to risk, says Paul Lefurgey, lead fixed-income manager at Madison Investment Advisors of Madison, Wis., who oversees the Madison Mosaic Core Bond (MADBX)
That doesn't necessarily mean dumping every bond or bond fund you own, however. Bill Walsh, president of Hennion & Walsh, an investment manager in Parsippany, N.J., says investors should treat bonds accordingly -- as a complement to equities.
"We look at fixed income as just that -- an income vehicle," Walsh says. "Income and safety. If you're looking for capital gains or more aggressive growth, you go with equities. Don't go into the bond market for that."
Just as investors were over-allocated to stocks heading into the downturn, they've made the same mistake with bonds during it, says Patrick Sporl, senior portfolio manager for the American Beacon Intermediate Bond Fund (ABIPX)
"The average Joe has to be very careful about chasing high-yield bonds, even though they might show all the nice numbers over the next few months," Sporl says. "A boring diversified bond fund isn't going to perform that way. But just let it do what it's designed to do, which is hopefully be up if the stock market is down."
Some patience is also in order. Eventually, the companies that issued all that debt will need to show that business is indeed improving, says Jeffrey Kleintop, chief market strategist at LPL Financial, a Boston-based financial-services firm. The corporate bond market will likely cool off or just stall in the third quarter, he says, as investors wait for proof that companies' bottom lines are getting stronger. "We need to see that earnings are improving fundamentally before we get further improvement [in the corporate bond market], and that's really more of a fourth-quarter story," Kleintop says.
Those who want to invest in corporate bonds are probably better off going with an actively managed bond fund, our bond pros say. Partly because bond-fund holdings are extremely difficult to understand and partly because of interest-rate risk. (As interest rates rise, bond prices fall. Active managers try to account for that all-important unknown.) For example, LPL Financial's top fixed-income picks for retail investors include Loomis Sayles Investment Grade Bond Fund (LSIIX)
As for bond buyers looking to manage their own fixed-income portfolios? Buyer beware, says Walsh. "If you go into corporate debt, you better know what you're buying," he says. "After the run-up we ve had in high yield, nine times out of 10 it's a recipe for disaster to buy any single issue, because an individual is not going to kick the tires."