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The bond bubble. It is slowly creeping into the consciousness of the mainstream investor. Once a topic of conversation reserved for fatalists, equity-only money managers and professional Fed watchers, there is an eerie feeling now conveyed through the popular press. It is the threat of rising or flat interest rates (both of which will spell miserable returns for investors in Treasuries, Munis and High-Grade Corporate Bonds).

Wall Street as always is trying to innovate in this area. Retirement income strategies are everywhere - mutual funds, ETFs and hedge funds are all claiming to be the right way to survive and thrive when bond returns fail to live up to the hype of the past 30 years, when rates were generally falling.

This is an area near and dear to my firm and me. Why? Because as I often say to my clients, "I met you 15 years ago and you are now 15 years older." While I don't get any credit for displaying advanced math skills, the point is clear: like many advisors, my clients' desire to produce a paycheck from their portfolio to replace the one they used to get at the office is a common objective. Our industry's challenge: How to deal with that via creation of intelligent investment strategies that allow advisors and their clients to follow through on their desire to skirt both the bond and stock bubbles of the future, while still striving for a competitive yield for their retirement portfolios.

I say without hesitation that this is THE top investment advisor issue of our time. Baby Boomer demographics are unforgiving, with so many people retiring every day. I was born in the last year of the Baby Boom (1964), so I know all too well that this trend toward prioritizing retirement income has long legs. After all, Boomers will turn age 65 in droves for another 16 years!

Despite the urgency of this investor need, I don't see many strategies being crafted to address the problem in a comprehensive yet easy to explain manner. Most of what is out there involves traditional balanced portfolio approaches, yield-reaching, mindless over-diversification across a zillion non-equity asset classes or strategies that successfully clamp down on volatility but do not produce sufficient income.

Why bother straying from the old bonds-for-income and preservation deal? Here is why: MATH! Specifically, my analyst Mark Jakupcik and I looked at the history of the 10-year U.S. Treasury Bond, with the goal of determining what the rate on that bond would have to go to in order for investors to receive a reasonable return over the next five or ten years. After all, a yield in the 2.8% range does not light one's toes on fire, does it?

Our conclusion: for the 10-year Treasury to return 4.4% annually for the next five years, 10-year rates would have to drop to near zero (about .3% to be more specific). Bond prices have fallen to the point where there is little juice left to squeeze out of that orange. The total return potential is gone and the yield stinks. So while 5% a year, formerly an easy return in bonds, is now a pipe dream, the bond market can still be routed and produce some large negative performance numbers. And lest you think that other high-quality bonds are a better bargain, they are-- but not by very much. It is clear that advisors and their clients need to look for additional or alternative strategies to achieve that elusive combination of income, preservation and some growth.

I am pretty amazed to find that while my firm has developed a strategy to attack this problem head-on, there are few others doing so. In classic Wall Street tradition, we will look back in five years and realize that what is today a nascent idea (no one has a very long-term track record of doing this, as far as I can tell), a sea of innovators and imitators will make this a more mainstream strategy.

The classic approach to generating portfolio income (bonds or balanced accounts) is DEAD. This leaves a lot of "sitting ducks" among us in the financial advisory business. They think that if they continue to promote the industry line of long-term investing via traditional portfolios of stocks and/or bonds, it will all work out in the end. In reality, with bonds effectively out of the equation for a while, the highest percentage shot for advisors is to look beyond gold and other alleged diversifiers of stock portfolios, and simply pair up stocks with what has the best chance of going up in value when stock indexes decline.

So, what is the punch line? How do you pursue the income and preservation mandate for your clients when existing solutions are fraught with issues and don't really do the job anyway? To me, the answer starts with active management of portfolio volatility and continues with a disciplined process for identifying, buying and selling yield-oriented stocks, and really comes alive when you document clearly for the client why you made buy and sell decisions (we call them "trade notes").

Shortly, my firm will release a study on the topic of hedged dividend investing. The study will include a set of data that backs up the fact that bond returns cannot mathematically replicate their returns of the last 5-10 years. We have run the numbers and they tell quite a story. They are convincing. The way advisors use bonds is over for now. Many just don't realize it yet. The reality will sink in quickly.

Editor's note: This article was originally published on 12/13/13.

Disclaimer: The views and opinions contained in this article are entirely those of Rob Isbitts of Sungarden Investment Research. This commentary is provided for information and educational purposes only.The information, analysis and opinions expressed herein reflect our judgment as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. All investments carry a certain risk and there is no assurance that an investment will provide positive performance over any period of time. Past performance is not indicative of future results. Rob Isbitts is an investment advisor representative of Dynamic Wealth Advisors, a SEC registered investment advisor.

Source: Hedged Dividend Investing: The Best Strategy You've Never Heard Of?