With interest rates so low and threatening to rise, more investment professionals are publicly warning the 30-year bull market for bonds may be over.

The latest is Lisa Myers, co-manager of Templeton Global Income Fund. The fund’s mandate is to own both stocks and bonds, but Myers says investors should not be buying the latter. When interest rates get this low, she says, there is only one direction they can go. “You don’t want to hold bonds. You want to hold equities.”

Interest rates have already risen in countries such as Australia and Norway and more will follow in the next six to nine months, starting with Asia. The picture is less clear in North America, but most experts believe it is only a matter of time before rates rise in the United States. When they do, Canada’s would soon rise in sympathy.

It’s a counterintuitive fact that bond prices fall as interest rates rise. Over the past 30 years, interest rates have mostly fallen, which means bond prices rose. Hence, a protracted bond bull market.

The reason for this inverse relationship is strictly mathematical. Once rates start to rise, no one is going to want to buy your bond paying less interest unless the price is discounted by a similar amount.

Even though Myers’ fund has moved in the past six months from a mix of 65% bonds and 35% equities to its current mix of 45% bonds and 55% equities, retail investors are moving in the opposite direction. In the third quarter, Americans pumped US$166-billion into bonds compared with US$4-billion into stocks.

In The MoneyLetter, AlphaPro Management Inc. president Ken McCord warns, “The end of a 30-year bull market in bonds is near. It’s time to prepare.” For three decades, bonds seemed to go only in one direction -- up -- with minimal volatility or nasty surprises. The idea of bonds as a safe harbour “is about to change,” McCord says.

The yield curve today is “incredibly low,” he says. A yield curve shows how much extra interest buyers receive for locking in to longer bonds, although on rare occasions the curve can become “inverted” with bonds at the short end paying more than long bonds. Currently, a five-year U.S. Treasury bond yields 2.3%, but investors willing to go out 30 years get only 4.2% -- scant reward for the higher risk of going long.

McCord suggests holding cash or iShares Canadian DEX Real Return Bond Index Fund. Aggressive investors could short bonds via his suggestion of Horizon Betapro’s U.S. 30-Year Bond Bear Plus ETF.

Curious if Myers’ employer shares her view, I bounced her bond thesis off Brent Smith, chief investment officer at Franklin Templeton Managed Investment Solutions. He oversees the mutual fund wrap program Quotential, with $7-billion invested. Portfolios range from all fixed-income to “maximum growth” equities, but most investors choose balanced portfolios. These have tight ranges for stocks and bonds but can vary by 10% overweight to 10% underweight. Until March 2009, portfolios were maximum underweight equities but by April the firm moved to maximum overweight equities.

“I’d definitely say equities will outperform fixed income and with inflation coming down the road, I agree with Lisa’s assessment that fixed income is a concern,” Smith says, referring to a reasonable time horizon of five to seven years.

The most bond exposure is in the Quotential Diversified Income and Balanced Income portfolios, currently 7% underweight bonds. Six weeks ago, managers got approval to add gold ETFs, now at a 2% weighting.

Managers are adding shorter-duration bonds and boosting exposure to global bonds via Templeton Global Bond Fund. Nassau-based manager Michael Hasenstab, Myers’ co-manager, says clients are internationalizing bond portfolios the same way they do with equities, and for similar reasons -- diversification and broader opportunities.

What about ladders of strip bonds, which many Canadians hold in their RRSPs? Advisors have traditionally suggested that as long as they are held to maturity, they are OK to hold. When they come due, you reinvest at whatever new interest rates are in effect. If rates gradually rise, your strip ladders will gradually pick up these higher rates as they’re rolled over.

But it may be time to trim some longer-dated issues, Hasenstab says. You won’t suffer capital losses if held to maturity, but you won’t get as much income and there are opportunity costs to staying put.

Financial planner Fred Kirby says investors are seldom compensated for the extra risk of holding bonds maturing more than five years from now. So, investors should prepare to take profits on longer-dated bonds to move to shorter-term issues or high-interest savings accounts. But the rally in stocks may mean portfolios are again overweight equities relative to bonds, so he’s wary of following Myers’ suggestion of buying more stocks.

Financial Post

jchevreau@nationalpost.com