Bill Bernstein: Make Peace With T-Bills

April 02, 2013 Burton Malkiel says--and he's certainly not saying to bet the farm--but he’s saying, why not integrate some pretty dependable large-cap stocks with dividend streams that have proven the test of time: the ATTs of the world. And there are certainly diversified equity vehicles organized around that principle. Do you buy it, or do you think that’s an accident waiting to happen?

Bernstein: Well of course it is. It’s a question of return and risks. The real return of ATT is fairly reasonable: You’ve got a nice healthy dividend; you may even have some capital appreciation, although that’s dubious. But you have to be willing—even with an ATT—to watch 30 or 40 percent of your capital disappear temporarily, and perhaps permanently. You’re talking about a market correction taking your beloved dividend stock down with it?

Bernstein: Right. But the dividend probably won’t decrease that much. What happened top to bottom from ’07 to ’09 was the S&P fell in price by more than 50 percent, but the dividend yield only went down by 23 percent, and in the Great Depression, prices fell by 90 percent and dividends only fell by half. The point is, who is doing this in your example? The kind of person who is doing this is someone who is used to safe assets, and who isn't prepared for the vicissitudes of the stock market. So grin and bear it, is what you’re counseling?

Bernstein: Yes; the person who’s used to T-bills and CDs is not going to be prepared for what happens to junk bonds and high-dividend-yielding stocks. In one of our early conversations about this topic of fixed-income investing, you talked about Pascal’s Wager—that you’re better off parking your assets in very short, safe maturities even if the return is disappointing, even negative, as you were saying a moment ago, rather than going out on the curve looking for a little bit of extra yield because the potential for “unpleasantness” is all too real.

Bernstein: Yes, and one of these years I’ll be right about that! That’s the catch, right? But you’re entirely comfortable with being tarred and feathered on that basis, because in your mind, there is no choice, right?

Bernstein: That’s right. There is no choice. And I still own a lot of risky assets, which have done really well the past three years. So it’s not like I’m crying in my beer. Would I have been better off owning lots of 30-year bonds? Sure I would have. But that’s not where I choose to take my risk.

To me, there are risky assets and there are riskless assets. To me, a junk bond or an emerging markets bonds or any T-note longer than 10 years is a very risky asset. So looking at the world of investment management at this time of low expected returns in fixed income, is the challenge not to blow it in terms of reaching for yield? Do you see things in such stark terms?

Bernstein: Yes, I do.



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