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Why investors should watch for asset class deception

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Nov. 24 2019, Updated 11:14 p.m. ET

At a time of ultra-low bond yields and more compressed expected equity returns, investors are using their stock portfolios to seek income while simultaneously building equity-like exposure in their bond portfolio. Russ and his colleague Kurt Reiman explain why this approach is becoming increasingly risky in some scenarios and offer five alternative investing ideas.

The U.S. investment-grade bond market has offered a sub-3% yield for 14 consecutive quarters, as measured by the Barclay’s Aggregate bond index. No wonder investors have lost interest in traditional higher-rated bonds.

 

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Market Realist – The previous graph tracks the yield returns of the iShare Core U.S. Aggregate Bond ETF (AGG), which tracks the Barclay’s Aggregate Bond Index, and compares it with the iShares Core U.S. S&P 500 ETF (IVV) which tracks the S&P 500. The yields have been low for the investment grade bond market in the past year. This has caused a lack of interest in higher rated bonds.

What has caught their attention instead? Asset class “cross-dressing.”

At a time of ultra-low bond yields and more compressed expected equity returns, and while stocks are typically more volatile than bonds, investors are increasingly opting for stocks that are behaving “bond-like” to generate income as well as riskier bonds, which have the side effect of building equity-like exposure – and risk –in their bond portfolio. This approach, however understandable, comes with its own hazards. Here’s why.

 

Market Realist – The low bond yields have pushed the investors to add riskier bonds that give higher yields like the SPDR Barclays Capital High Yield Bond ETF (JNK) and the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) to their portfolio in order to strengthen their incomes. The previous graph shows the historical prices of the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) which have been going up over the past year. Investors are considering corporate bonds with higher yields instead of investment grade bonds like AGG and the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD).

Continue reading the next part of the series to learn about the risks of asset class deception.

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