If financial advisers weren't spooked enough by the threat of rising interest rates, last month served as a scary reminder of just how widespread the carnage could be.
It has caused some to start looking for alternatives and others to prep their clients for the inevitable pains of staying with pure bonds.
Interest rates shot up a startling 50 basis points last month, thanks to concerns that the Federal Reserve will begin tapering off its quantitative-easing program sometime this year.
The move left hardly any bonds undamaged in its wake. Every bond fund category at Morningstar Inc. posted a negative return for the month, save for bank loans, which ended last month virtually flat.
Even Bill Gross, manager of the world's largest bond fund, couldn't escape. His flagship $282 billion Pimco Total Return Fund (PTTAX) lost 1.9% last month, its worst showing since September 2008.
Interest rates have come down since the 10-year Treasury bond peaked at 2.23% on May 29, but things are likely to get worse before they get better.
“There's a lot more room for rates to go up than down,” Financial Industry Regulatory Authority Inc. chief executive Richard G. Ketchum told Reuters in a recent interview.
“Losses of 5% to 10% are perfectly reasonable to expect,” he said. “They may be safer than many investments, but they're not riskless.”
The dire outlook is causing advisers such as David Diesslin, chief executive of Diesslin & Associates Inc., to rethink how to handle bonds.
“We can't eliminate bonds, but we want to minimize the negative implications of rising rates,” he said.
Mr. Diesslin has been placing more trust and client assets in bond funds that give managers flexibility to invest across multiple geographies and asset classes.
He also has been adding conservative dividend-paying stocks and looking at alternatives such as direct real estate investment.
LOSSES 'INEVITABLE'
“It's challenging our concept of the 60/40 portfolio,” Mr. Diesslin said.
Not everyone is ready to throw in the towel on the traditional way of investing in bonds, however.
Derek Tharp, an adviser at Mote Wealth Management LLC, has been spending his time preparing clients to see losses in bond funds in the hope that it will make them less likely to panic when they actually see red on their statements.
“We've talked to our clients about how losses on paper will be in-evitable,” he said. “As long as we're holding on to them for the long term, it won't result in an actual loss.”
So far, Mr. Tharp hasn't heard any rumblings from clients about last month's bond volatility.
“It's not as scary as the bottom falling out of the [stock] market,” he said.
