You thought correctly, but as the Wall St. Journal pointed out today, the world of bond funds is undergoing a disconcerting trend: they are owning more and more stocks instead of bonds. To be sure, this ownership is permitted and disclosed to investors, but inside the black box of bond mutual fund investing, things are changing.
As the WSJ article points out, there are now 352 mutual funds classified as fixed income funds which now hold stocks as part of their portfolios – one notable extreme holding a whopping 49% in dividend-paying stocks! And with interest rates as low as they are and dividends as high as they are, who can blame them? And, really, what could go wrong?
We have not been fans of owing your fixed income investments in a fund form for many reasons, but this is just one more. And in reality, the move by bond funds to own dividend-paying stocks mirrors the same impulse we see in many of our own clients. It is not infrequently that we are counseling clients to stay the course on their fixed income allocation and resist the temptation to buy, say, Intel Corp, for its sexy 3.7% yield.
The thing about that 3.7% yield, though, is that it comes with some fairly common swings in the price of Intel stock. The chart below shows the last 6 months of Intel prices, and you can see it has gained a welcome 8.3% during that time – AND you got half of that 3.7% dividend, so another 1.85%. Gotta like that, right?
Well, like with any stock, Intel’s 8.3% price growth over the last 6 months wasn’t exactly a straight line. Look at all the red markings: each of those represents a drop of 4% or more over usually a period a week or so. If you bought Intel to earn 3.7% in dividends over a full year, it would be more than a bit disappointing to lose that much (or 2x or 3x) in just a week or two. If you think that the 8.3% overall gain makes that volatility perhaps a bit more palatable, you may be surprised to learn that you were gain-less until the last 9 trading days of the 6 month period.
The point is that even the best dividend-paying stocks are still stocks, and even the lowest-paying bonds are still bonds. We buy bonds for clients to reduce volatility and introduce certainty into a portfolio. Do we like to be able to generate some income along the way? Absolutely. But that’s the gravy, not the sole purpose of your bonds. At NWIC, your bonds really are bonds, and we intend to keep it that way.