U.S. retail investors have pumped far too much money into bond funds and may be headed for shocking losses when interest rates rise, several top asset management executives warned on Thursday.
As a reflex against investing in the jittery world of stocks, many individual investors have maxed out their allocation on bonds. But a jump in interest rates would hit bond prices and could trigger significant losses in bond-heavy portfolios, the money managers said.
"We don't think investors are really ready for the negative returns that could be coming," said Marie Chandoha, chief executive of Charles Schwab Investment Management, on a panel discussion at the Investment Company Institute's general membership meeting in Washington D.C.
"When bond prices drop, that's going to be a shock to them," Dodge & Cox Chairman and CEO Kenneth Olivier said, also on the panel at ICI, the leading trade group for U.S. investment companies. Retail investors are at the maximum allocation for bonds in their portfolios, he said.
While withdrawing money from equity funds for the past few years, U.S. investors have been pouring money into bond funds, including $124 billion last year and $241 billion in 2010, according to the ICI. At the same time, investors withdrew $130 billion from stock funds in 2011, up from $37 billion of withdrawals in 2010.
"We may be in a dangerous point in the cycle," said Greg Fleming, president of Morgan Stanley Smith Barney. Still, bonds have a proper role in a diversified portfolio of assets, he said.
Some attributed the move into bonds as a reaction to the two bear markets in stocks in the past decade feeding a growing reluctance to take much investment risk.
Uncertainty about the coming U.S. presidential election and fear about the financial crisis in the Euro zone have also fanned investors' desires for bonds, said Ronald O'Hanley, president of asset management at Fidelity Investments in Boston.
The mutual fund giant, which has suffered significant outflows from its stock funds, is working to educate investors about other strategies, such as global equity income funds that focus on stocks that pay dividends, O'Hanley said. Fidelity unveiled a new global dividend strategy on Thursday.
Near-zero short-term interest rates have also contributed to the trend because investors have been moving money out of money market mutual funds into bond funds as they seek higher yields.
Last year was the first time assets in bond funds exceeded assets in money market funds, noted Peter Crane, president of money fund research firm Crane Data LLC. Bond funds held about $3 trillion, versus $2.6 trillion in shorter-term money funds.
The shift to bonds has hurt the earnings of most money management firms, as well, because stock funds carry higher fees and can often be more profitable than bond funds.
Capital Research and Management Company Chairman Paul Haaga, the moderator for the discussion, jokingly asked panel members, "Why don't you tell (investors) they can't have any more bonds because it's not good for them anymore?"
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