Dividend Stocks Can't Take The Place Of Bonds

Includes: BND, JNK, MCD
by: MyPlanIQ

We are all very well aware that the new normal of increased volatility and low interest rates forces us to reconsider our investment strategies. I have been reducing my bond holdings and boosting my dividend stock holdings. However, I was reviewing what is possible with bonds and it slowed my migration away from Bonds, so I thought I would look at another view of Bonds.

My basic thought was: Buy and hold diversified stocks or ETFs and be very careful about expense ratios for any stock mutual funds or ETFs. We recently looked at the Forbes low cost ETF selection and concluded that was worth a look. When it comes to bonds, however, I think I am willing to pay for the best of the best to actively manage bond allocation as this is an area where we are in an undiscovered country.

So, I decided to compare four difference approaches to see whether I can find a bond selection that while it may not be stellar, can be a stalwart backstop to volatility and provide income.

My selections:

  • McDonald's (NYSE:MCD) has had a remarkable run of consistent growth and increasing dividends and I am taking this as the best of the dividend stock selections. You can put your own proxy here but it is definitely one of the best stocks with which to contrast a bond selection
  • Vanguard's total bond ETF (NYSEARCA:BND) gives us a safe assets reference
  • Barclays High Yield Corporate Bonds (NYSEARCA:JNK) gives us a high growth alternative but has increased risk
  • I am returning to the strategy that takes the best bond fund managers as determined by Morningstar and swaps in the best one based on a momentum calculation on a monthly basis -- this can be stretched out to quarterly if desired.

My goal is to fill in the gaps in my understanding of the different bond strategies and see what they can deliver.

Portfolio Performance Comparison

Portfolio/Fund Name YTD
1Yr AR 1Yr Sharpe 3Yr AR 3Yr Sharpe 5Yr AR 5Yr Sharpe
P Bond Funds Momentum Based on Upgrading Fixed Income Managers of the Year's Funds Monthly 2% 2% 49% 14% 298% 9% 177%
BND 1% 7% 186% 6% 160% 6% 94%
MCD 34% 28% 123% 25% 104% 18% 89%
JNK 5% 5% 40% 19% 172% 4% 14%
Click to enlarge

As I look back over the longer time horizons, the ability to swap the best bond fund managers in and out has delivered solid returns and low risk. Who wouldn't take 9% AR? Only MCD can beat it.

As I look over the shorter period -- when we have entered this new normal, the swapping in and out of bond fund managers has not yielded results. The unmanaged bond ETF had beaten it handily. This is dissonant information for me, as I like the idea of swapping in and out funds based on a mathematical formula, but this data says it doesn't work. We have further data that shows that our SIB ETF portfolios (one ETF in each asset class) has beaten out portfolios with more selection that swaps more in and out.

Click charts to enlarge.

Three Month Chart

One Year Chart

Three Year Chart

Five Year Chart

As I say, this is not what I want to see but over the past year -- that the simple, widely diversified bond ETF has done the best. It seems that the momentum scores don't lead you to a good result.

Personally, I use PIMCO funds, as I think these guys know what they are doing and I have see YTD returns in the 5% region.

The conclusion I draw from this is that it is possible to find bond funds that have a decent return. I have shifted my own thinking to ensuring a stable bond core and then augment this with stable, dividend-bearing stocks to provide extra income and growth.

I am not going to tinker with a momentum approach until I have more solid data that it is working.

Disclosure: I am long MCD.

Disclaimer: MyPlanIQ does not have any business relationship with the company or companies mentioned in this article. It does not set up their retirement plans. The performance data of portfolios mentioned above are obtained through historical simulation and are hypothetical.