Wednesday, December 10, 2008

The Big Blunder

One of the smartest guys in the room is David Swensen who runs the Yale endowment and wrote a brilliant book on portfolio management some time ago. The greatest mistake I've made in this past year has been to not heed one of his dictums, or worse half of one of them.

"Bonds exhibit the most extreme misalignment of interests, as most debt issuers benefit by reducing the value of debt obligations, resulting in direct conflict between the goals of borrowers and lenders....

...Investors frequently own more fixed income than necessary to protect against hostile financial environments, leading to behaviour that undermines the fundamental purpose of holding bonds. Confronted with a larger than ideal allocation to fixed income, investment managers often seek to enhance returns by accepting credit, option, and currency risk. Although under normal circumstances, risky bonds might generate superior returns, investors face likely disappointment in times of financial stress."

Mr. Swenson pretty well nailed it in his book published in 2000. I knew that reaching for yield could end in tears and I chose to put clients into a bond fund that has long been among the best multi sector bond investors. I trusted the value of the management of the fixed income portion of porfolios at a time when market stress erupted. The credit debacle decimated the value of the Loomis Bond Fund as every variety of bond other then US Treasury issues plummeted.

The value of struggling to gain the incremental gains in yield in fixed income has been a lesson to many. There are no free lunches.

John Barnyak
Stonehouse Asset Management