Tomoeh Murakami Tse

Retail Investors Are Banking on Bonds Even After Resurgence of Stock Markets

New York. Small investors, still jittery even after stocks roared back to life from the financial crisis, are looking for less-risky ways to reboot their portfolios.

Many small investors who dumped stocks throughout the downturn have remained wary, content to sit on the sidelines as the Standard & Poor’s 500-stock index soared 65 percent from its lows in March to ring in the new year. But instead of buying back stocks, individual investors have increasingly poured their money into bonds, which are considered safer but could pose risks in 2010.

Investors in mutual funds, a popular way for small investors to access the markets, pulled roughly $250 billion from stock funds during the market downturn from October 2007 through March, according to the Investment Company Institute. During that 17-month period, managers of money-market funds saw a hefty $933 billion inflow as investors sought safety. Just about every investment was ravaged, including mortgage securities and stocks in emerging markets.

Although signs of an economic recovery began budding in spring, nine months later, retail investors have yet to jump back into stocks in full force, instead steadily putting money into bond funds in ever-larger sums.

With the damage to their retirement accounts still a recent memory, many small investors who have been sitting on their cash perceive investing in bond funds as “dipping your toe back in the pool,” according to Rebecca Schreiber of Solid Ground Financial of Washington. “This is how people are reintroducing themselves to the market.”

There is some chasing of past performance, analysts said, with investors pulling out of money-market funds earning near-zero interest to go after returns in bond funds, which returned an average of 13.5 percent for the year, according to Lipper, a data company that tracks mutual funds. Equity funds, meanwhile, gained an average of 34 percent.

But fund investors hoping for similar gains in 2010 will probably be disappointed, analysts say. High-yield bond funds, which invest in the debt of riskier companies with non-investment-grade ratings, were trading at average discounts of 50 to 60 cents on the dollar at their lows last year. They are now back up to trading in the 90 cents on the dollar and up, according to Ken Taubes, head of portfolio management at Pioneer Investments of Boston. High-yield bond funds returned a whopping 46 percent on average last year, according to Lipper. They are up nearly 4 percent over a two-year period.

“Returns will be greatly reduced from last year but still reasonable,” explained Taubes, who expects high-yield funds to return somewhere between the high single digits to the low teens for 2010.

“All those really big historic bargains are gone,” said Miriam Sjoblom, senior bond fund analyst at the investment research company Morningstar.

Analysts warn that bond investors may be in for a rude surprise when interest rates, which are at historical lows, eventually start to head back up. In general, bond prices take a tumble when interest rates rise and rally when rates fall.

Analysts say investors should stay away from long-term bonds, which are more sensitive to rising interest rates, and stick to shorter-term issues.

Aside from high-yield funds, emerging-market debt funds were among the best performers of 2009, returning 32 percent for the year. Meanwhile, general US Treasury funds lost 6 percent.

Stock analysts do not expect the supercharged returns of 2009 to continue into 2010. Many investment pros are expecting stocks to return to more normalized gains of around 8 percent. In a recent survey of money managers by Russell Investments, 42 percent said they expect US stocks to rise at least 10 percent and 37 percent predict a rise of up to 10 percent.

After falling 57 percent from its October 2007 high, the S&P 500 soared 65 percent to finish 2009 with a gain of nearly 24 percent. The index was still off 29 percent from its record high in October 2007 and finished down 24 percent for the decade. The Dow Jones industrial average of 30 blue-chip stocks ended up 19 percent for the year but down 9 percent for the decade. The tech-heavy Nasdaq index closed up 44 percent for the year but down 44 percent for the decade.

While nearly every category of stock fund finished up for the year, funds that invest in shares of smaller companies outperformed those that invest in larger companies. The value funds that invest in large companies gained 23 percent for the year and value funds that invest in small companies gained 33 percent, Lipper said. Large-cap growth funds returned 35 percent, while small-cap funds gained 36 percent.

Among the sector funds, global science and technology funds fared best, rising 69 percent. Basic materials funds followed with 65 percent. Utilities and financial services funds each returned 16 percent. China funds roared, gaining 69 percent, while Japan funds returned a modest 7 percent, Lipper reported.



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