In a recent piece for Forbes, top bond fund manager Bonnie Baha of DoubleLine offers five common — and dangerous — misconceptions about the fixed income market.
Among the misconceptions: Market-cap-weighted investing makes sense in fixed income.
“Most investors gain their initial market experience by investing in stocks or mutual funds. The misapplication of equity investing principles to bond investing has the potential to backfire spectacularly, specifically when it comes to index investing weighted by market capitalization,” Baha says. “This amounts to an adverse-selection process for fixed income: The investor winds up purchasing the most indebted companies.”
Baha also says investors are wrong to think that dividend stocks are a good bond substitute. “Today’s low-yield environment has pushed investors out of bonds and into dividend stocks,” she says. “This is a potentially disastrous strategy. The coupon payment on a bond is a legal obligation of the issuer. The dividend payment on a stock is almost always discretionary and can be changed or cease at any time. Furthermore, the risk of principal loss is greater for common stocks. Remember the hierarchy of claims in a bankruptcy means bondholders get paid something and equity holders get wiped out.”
Click here to read all of the misconceptions Baha cites.