When Risk Aversion Leaves Investors Open to Risk

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Know what you’re investing in. To the surprise of many, certain fixed income portfolios don’t always provide the diversification investors expect. Much of this is due to risk aversion and the fact that fixed income instruments have varying degrees of risk. During sharp downturns, investors tend to dump risky assets in favor of safe-haven investments. While this is most often a flight from equities, it can also be a flight from high-yield/high-risk bonds. In other words, certain fixed income instruments might not protect investors during a stock market sell-off.

The Paradox of Active Fixed Income Management

“Lately, I have been fielding a lot of questions from investors who have been disappointed with the performance of some of their fixed income investments. The basic story is always the same. The investor built a diversified, multi-asset class portfolio. The investor included fixed income in the portfolio to provide diversification from riskier asset classes such as equities and commodities. But now the investor is unhappy with their portfolio’s performance. Why? On the surface, it appears they did everything “right.” The fixed income holdings were meant to provide an anchor in the portfolio and some stability in uncertain times. As we know, this year markets have been highly volatile, Treasury yields have declined, and most fixed income asset classes have had strong performance in 2011.”

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