More Strange Advice on Investing

An article on safer alternatives to stock market investing in the Oct 28 NYT entitled:

Shedding Stock-Market Vertigo (but Still Making Some Money)

starts out logically enough ,mentioning some sensible alternatives including CDs and Treasury Inflation Protected Bonds.

Then the article veers off into the strange recommendation of actively managed bond funds. As we have noted before there is nothing particularly safe about these funds. The investor is simply giving his money to a bond “guru” who takes bets across the entire spectrum of fixed income investments. Much as with an actively managed stock fund, you never now what you own and what risks are lurking in the portfolio, particularly in the currently unstable bond market.
The article cites the recommendations of a Morningstar analyst (my bolds):

he has identified two — Metropolitan West Total Return and Pimco Total Return — as likely to benefit from credit market fears.
“They both have a history of opportunistic buying,” he explained. “Great managers love volatility.”

They may love volatility but is that what an investor really wants when he flees from “stock market vertigo”?

Mr. Peterson of Schwab likes Pimco Total Return and the Loomis Sayles Bond fund, which has international exposure, along with high-yield holdings intended to enhance performance.

Translation: they load up on credit, currency and sovereign risk to squeeze out higher returns .

Daniel J. Fuss, the Loomis fund manager, has excelled at finding the optimal mix of investment-grade and junk bond holdings, Mr. Peterson said. “Loomis is more of a credit analysis play,” he said. “They shift between investment grade and high-yield.”

This manager puts the conservative part of your portfolio in the riskiest types of bonds “high yield (junk) bonds. And with many forecasting a recession this is precisely what you do not want to own.

In all, his fund holds 22 percent in below-investment-grade holdings, along with roughly 17 percent in nondollar credits, chiefly in the Brazil real, the New Zealand dollar and the Mexican peso. These issues provide higher yield than dollar-denominated debt and would benefit from a continued decline in the dollar. This year through Thursday, the fund has produced a total return of 9.2 percent and has outperformed its multisector bond category average in each of the last five years.

Junk Bonds, Brazilian Real Bonds and Mexican Peso Bonds....Does that look like a portfolio designed to prevent market vertigo ? It looks to me like an accident ready to happen.

Once again it bears repeating. The only reliable way to reduce the risk of a portfolio is to increase the holdings of short term treasury bonds, treasury inflation protected bonds or investment grade bonds. Anything else is some kind of a bet on the direction of interest rates, credit spreads, currency risk, or sovereign risk. In fact a strong case could be made that even the investment grade bonds should be excluded from the list. Certainly a terrible choice would be an actively managed bond fund where you have no idea what risks the manager is taking.