Advisers question the value of bonds in client portfolios

With bond yields hovering near historic lows and the Federal Reserve promising more of the same, financial advisers are increasingly making the case for trimming or even eliminating bond allocations in client portfolios.

The anti-bond movement is most prevalent among younger advisers, and advisers who work with a lot of clients under the age of 40.

“I’m personally 100% in equities and I do occasionally have tactical cash allocations,” said Graham Miller, 32, owner of Wiegand Financial Group.

While Miller does position bonds inside many of his clients’ portfolios when appropriate, he believes there are certain client profiles that just don’t benefit from fixed income. For some of those clients, the bond allocation is replaced by alternatives such as futures, real estate and precious metals.

“Everything depends on what the market is giving you, and now is certainly a time when I would be more averse to bonds,” Miller said. “Generally speaking, if someone has an infinite timeline and a high-risk appetite, 100% equities would be appropriate.”

While the strategy might seem logical for younger clients who say they can stomach the volatility of the equity markets, some critics say shunning fixed income misses the point of portfolio diversification.

“Removing bonds from a portfolio is short-sighted and will cause additional problems down the road,” said Kent Fisher, founder of Southern Investment Management Collective.

Fisher admits the unusually low yields on most fixed-income investments have driven him to reduce bond allocations to around 30% of a balanced portfolio, but he does not believe in removing bonds entirely.

“You buy bonds to attain strategic goals like a deflationary hedge, a source of liquidity and as a stabilizer -- not for the yield,” he said. “If bonds are the only thing you’re investing in, the yield is a problem, otherwise the growth comes from the equity portion, not the bond portion. Very few people could stomach a 100% stock portfolio, that’s why you bring in some bonds.”

But Devin Pope, senior wealth adviser at Albion Financial Group, also supports removing bond allocations for younger clients.

“For someone with a 20-year time horizon such as a 40-year-old, we would not recommend owning bonds,” he said. “If you have time, why do you need the safety and diversification that bonds provide?”

Even for those client portfolios where Pope does include bonds, he keeps the allocation to around 30% and sprinkles in exposure to dividend-paying stocks and preferred stocks for income.

But industry veterans who have been through their share of market cycles bristle at the idea of stripping away the one asset class that has most reliably provided ballast in times of volatility.

“It’s naïveté  to focus on poor bond returns and not their place in a balanced portfolio,” said Harold Evensky, chairman and co-founder of Evensky & Katz/Foldes Financial Wealth Management.

Evensky added that the anti-bond trend is likely temporary, “until the next major market correction when they realize that stock returns don't always go up, and in those cases, it's nice to have some [ability] to buy stock at bargain prices.”

Robert Hernandez, lead adviser at Financial Planner NY, believes the growing aversion to fixed income could be related to the seemingly unstoppable stock market and a general inability among younger investors to grasp the concept of getting older.

“This generation of young people is far more plugged into the stock market, with kind of a chase-the-news factor,” he said. “Some advisers I talk to say it’s hard to have a conversation about retirement when clients are focused on Tesla hitting new highs.”

Beyond the dismal bond yields, the reality of bond math can also look like an unnecessary risk to some advisers.

“Right now, there is a perfect storm of risk in an asset class that should otherwise be protecting the portfolio, and that has prompted us to reconsider how we allocate the fixed-income portion of our portfolio,” said D. Scott McLeod, president and chief executive at Brown Financial Advisory.

The Vanguard Total Bond ETF (BND), for example, now has an average duration of 6.6 years, which means that if interest rates rise by 1%, the ETF is poised to lose about 6.6% in principal value.

“We haven't abandoned bonds, but we are exploring alternatives to the simple way of investing in fixed income,” McLeod said. “I’m not a younger adviser, but certainly for those clients in a higher-risk category, we’ve taken out of fixed and are holding more in cash, because we think the rate risk is too high.”

The current balanced portfolio for McLeod’s clients holds about 10% in cash.

“We haven’t sold it out of bonds completely but are definitely migrating toward alternatives to bonds,” he said. “Clients love the cash because it takes credit risk off the table and the money market yield is not that much lower than the bond index.”