By Tom Bradley

Ballast /bal•last (noun)/ Any heavy material used to stabilize a ship or airship. Also: weight, bulk, stabilizer, balance, counterweight, counterbalance.

In a recent post I suggested that one reason clients are resistant to re-balancing their portfolios is that our outlook for bonds, and by association, our Income Fund, is pretty modest. Indeed, we’ve been warning clients in our writing and presentations over the last year that they shouldn’t expect the Income Fund to produce the kind of returns it did over the last 5+ years.

So why should clients own the Income Fund when the expected return for bonds is 2-3% per annum?

First, the textbook answer is that bonds expose a portfolio to different types of risk - interest rate and credit risk – which will contribute to returns (in excess of the risk-free rate). Because these returns come at different times than stocks, bonds help to smooth out a portfolio’s returns. And of course, bonds provide a steady stream of income.

Second, there are behavioural reasons for owning bonds. By dampening down a portfolio’s short-term volatility, they help investors stay on track during the tough times in the stock market. Sound decisions (and non-decisions) at critical moments are important contributors to long-term returns.

And third, the Income Fund is designed to beat the bond market. It pursues a number of strategies to generate higher returns, with a particular emphasis on corporate and high yield bonds, and income-oriented stocks.

It sounds like ‘ballast’ is a good description for the bond portion of your portfolio. When stock markets are flying, bonds feel like a heavy weight dragging down returns. In average times, they stabilize the portfolio and provide income. And when stocks are in the dumps, bonds are a good counterbalance (i.e. interest rates come down and bond prices go up).

In our advice to clients with balanced portfolios, we recommend a minimum load of ballast, er bonds, but not zero.