Why I hold some bond funds even though equities have more upside (19 Jun 2009)

Markets have been going through a correction this week. As I mentioned in my previous entry, I took the opportunity to put in a further $10,000 into my portfolio. My continued confidence in equity markets stems from the strong belief that markets are limited to a forward looking view of just 3 months, at most 6 months. A fundamental question I ask myself at this point is "Will a recovery take place within this year, and will markets be higher at the end of 2 years times, when the economic recovery is in full swing?"

If the answer is yes, then corrections are opportunities for me to add more into my portfolio at cheaper prices. However, to have the patience and confidence to adopt such a strategy, a disciplined appraoch to investing is necessary. This means keeping one's risk within acceptable levels. For me, a suitable proportion between my bond and equity assets is also important. As some might note from lookiong at my portfolio, I have about 15% invested into bond funds (high yield bond and emerging market bond). This means that my total equity fund exposure is 85% of my portfolio.

I am not adverse to changing this ratio I have between equity and bonds. But only if I deem that the markets have moved in such a way that equities are available at great bargains, and it warrants going into 95% equity exposure instead of 85%. If markets continue to go up, then I will let them run, while ensuring that my new investments continue to include small proportion in bond funds. I have often spoke about rebalancing, and in truth, rebalancing works better when you have different assets classes that performs differently over time.

In todays markets, many equity markets are getting more closely correlated. There are differences in upside, but all too often, the direction of market's movements are similar. Only a seperate asset class from equities like bonds can give you a more diversified portfolio. Some investors prefer to stay all in cash instead. The danger though is that they adopt too risky an appraoch, they are either "all into" markets, or "all out of" markets. Its a very high risk appraoch towards investing.

Also, a further danger of staying in cash is that inertia sets in far too easily. Because nothing is going to happen if you leave your money all in cash, there is a strong tendency not to touch it. By the time you feel a greater urgency to shift money from cash into investments, its usually because you have missed most of the market's upside, and the sky is "clear". Being in cash is not being invested. Thus, even though I feel that the bond funds I have are likely to underperform my equity funds over the next 2 years, I believe they will definitely outperform cash. Plus it is a way of "forcing myself" to stay invested so that inertia does not set in.