WSJ: Fund managers increase risk to offset costs, boost returns

How is your bond fund manager beating (or just keeping pace with) its benchmark?  Most likely by taking on more risk, according to a recent study conducted by Morningstar at the request of the Wall Street Journal. (Full story is here: http://on.wsj.com/OHOfvw, originally posted 9/20/12)

While still comparing themselves to broad based, high quality benchmarks such as the Barclay’s Aggregate Bond Index, many fund managers are reaching for yield in mortgage debt, high yield bonds and emerging market debt. By slowing sliding down the risk scale, these managers are able to boost yields and returns.  In today’s risk-starved environment, this has paid off in the short term.  Investors everywhere are dismayed by the low yields available on high quality (AAA and AA) debt and are driving up prices on riskier bonds across the board.

If you want to increase risk in your fixed income portfolio, that’s just fine, but let’s agree that it is inappropriate to compare your performance to a conservative benchmark like the Barclays Agg. We don’t have to remember too far back to have evidence of the consequences of these risks.  It was just 2007 when managers starting reaching for yields again, loading up on mid and lower-grade corporate debt to boost yields and offset expenses, just to see many so-called “core” bond funds take a beating when markets lost their appetite for risk in 2008.

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