No-Load Fund Analyst recommends unconventional bond funds

By Steven Goldberg
Sunday, January 24, 2010

The stock market has performed magnificently of late. But the gurus at the No-Load Fund Analyst newsletter forecast that returns for U.S. stocks over the coming five years will be in the low to middle single digits -- far below the long-term annualized return of just under 10 percent.

I don't share the newsletter's depressing outlook. But I take what its editors say seriously. They are smart, careful investors. In recent years, I've found their asset-allocation calls more helpful than their fund picks. What's more, the lousy returns they're predicting are in line with what a lot of other top market strategists are saying.

To earn healthier returns in the coming years, Jeremy DeGroot, chief investment officer at No-Load Fund Analyst, is most excited about a handful of unconventional bond funds. But don't expect them to return 10 percent a year, either.

These are long-term investors who don't try to time the markets or make drastic changes to their recommended asset allocations. They tend to adjust those allocations on the margin based on their assessment of economic conditions and valuations of different asset classes.

DeGroot and his colleagues forecast grim returns for nearly every part of the stock market. "We don't think this is a typical recession cycle," he says. "Recoveries from financial crises, such as this one, tend to be worse than average recoveries."

DeGroot says stocks face several other headwinds, including:

-- Consumer spending will recover slowly because people need to rebuild their savings and because of the negative "wealth effect" caused by the decline in home prices and stock prices, which are generally still below their 2007 highs.

-- The growth of corporate earnings is likely to remain subdued over the next five years. Stubbornly high unemployment, huge government budget deficits and increased taxes will all hamper earnings growth.

-- Price-to-earnings ratios are above their long-term average.

For those reasons, No-Load Fund Analyst's balanced portfolio recommends investing 23.5 percent of assets in stocks of large U.S. companies. That compares with a normal weighting of 40 percent. The letter recommends placing 3 percent of assets in stocks of small U.S. companies, compared with 8 percent.

DeGroot and company have even sold their emerging-markets stock funds because they no longer believe the potential returns justify the risks.

They see promise in a handful of unconventional bond funds. These include Pimco Unconstrained Bond D. They also like emerging-markets bond funds, especially Pimco Emerging Local Bond D.

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