How Bond Funds Can Outperform Equities

Three years ago, the US credit system experienced something of a collapse, sending global markets into a whirlwind (a downward whirlwind it should be added). With that, a lot of investors were reminded of the importance of a proper asset allocation model, forcing them to re-examine their risk tolerance levels. Since the market caused many sleepless nights and self-doubt, the topic of risk tolerance has resurfaced, forcing both aggressive investors and conservative savers to realize that their traditional savings and wealth-building vehicles needed to change. For the conservative investor, that came with the realization that term deposits and treasuries could not be relied upon to maintain anything more than the rate of inflation.

The aggressive investor, however, also has had to revisit asset allocation with added emphasis on the income class, which aggressive investors have traditionally shunned from their portfolios in favor of more aggressive equity class investments. But the income class has evolved tremendously over the last decade or so.

Increasingly, bond funds have taken on greater risk profiles, investing high yield investments that not only provide better income streams, but whose underlying debt respond to various market forces in much the same way that equity assets respond. When you really get to know these high yield investments, it becomes clear that they not only provide greater volatility than some equity funds, they pay greater income and offer just as much growth potential. Meanwhile, they achieve these benefits while taking on much less risk.

In a market where all else is equal, your bond investments will always have less risk than equity investments.

The problem has been in the rating systems used by companies like S&P and Moody's, both of which came under fire following the collateral debt obligations (CDOs) collapse in 07 and 08. Now you have B-rated bonds that just two years ago were solid investment-grade bonds. And with the spreads between corporate and government issues being wide, the individual investor stands to capitalize. Some of the best bond funds will generate returns far greater than conservative equity funds. Expenses are low because trading is lower. Overall, bond funds can provide better returns than equity funds, with less risk.

They are clearly worth considering.
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