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The new year is less than two weeks old, but already economists and money managers alike are offering up their prognostications. Economic data seems to indicate that a slow, fragile recovery has taken hold, although unemployment remains stubbornly high and probably will for quite some time.
As shell-shocked investors eye the stock market, several trends in the mutual fund arena are already taking shape. While some of these trends may end up being beneficial for investors, here are three that you should watch out for.
1. Investors' rediscovered love for bonds
Playing Monday morning quarterback isn't just for sports fans: Investors are notorious for their rearview mirror approach to investing. In response to the market's harrowing drop in 2008 and early 2009, Americans have shifted billions of dollars into the perceived safety of bond funds. According to Morningstar data, through November of last year, bond funds raked in $320 billion in new assets last year, while stock fund inflows remained flat.
But folks who think bonds are risk-free or that they will guarantee a certain level of return may be in for a rude awakening. Given that interest rates are still near historical lows, rates have almost nowhere to go but up, which means bond prices have nowhere to go but down. True, bonds outperformed stocks during both the most recent bear market as well as the tech bust of 2000-2002, but Treasuries fell sharply last year as the stock market rallied.
Every single investor should have at least some fixed-income exposure to reduce overall volatility in a portfolio. There are a number of solid, actively managed bond funds out there, as well as some inexpensive, broad-based exchange-traded funds like the iShares Barclays Aggregate Bond Fund (NYSE: AGG ) and the Vanguard Total Bond Market ETF (NYSE: BND ) .
But switching into a "safer" asset class after most of the damage has been done isn't a recipe for success. If the stock market's antics over the past few years have made you genuinely rethink your risk tolerance, then maybe owning more bonds isn't a bad idea. If, however, you're hiding among the fixed-income fray in hopes of avoiding further stock market troubles, odds are good you're going to miss out on some pretty decent price appreciation in the coming years.
2. The expanding universe of actively managed ETFs
You already know that money managers aren't content to leave well enough alone. If there's an opportunity to make money with a shiny new product, even if investors probably don't need it, fund companies will find it.
The area that's shaping up to be 2010's hot deal is actively managed ETFs. T. Rowe Price (Nasdaq: TROW ) and PIMCO have recently filed paperwork to offer such funds, and BlackRock's (NYSE: BLK ) iShares has expressed interest in increasing its active exposure as well. While there are 15 actively managed exchange-traded funds on the market now, that number is expected to rise to 40 this year.
Don't get me wrong -- I think ETFs are great. They are an efficient, low-cost option for investors who want simple, broad-market exposure. But with the advent of actively managed ETFs, one of the asset class's primary benefits will be compromised -- the low price. With active management comes greater costs.
Actively managed ETFs are typically more expensive than their passive cousins, and in some cases, quite a bit more expensive. That may make these new versions not such a great deal. I'm always a bit wary of new products with no track record, and actively managed ETFs certainly fall under that category. For now, stick to well-diversified index-based ETFs and let someone else be the guinea pig.
3. Red-hot money flowing into commodity funds
I know: No one wants to hear anything bad about gold. After all, the SPDR Gold Trust ETF (NYSE: GLD ) is up more than 165% over the past five years, and with our nation's huge budget deficit, easy monetary policy, and a collapsing dollar, why wouldn't gold be on track to double again in the next year or so?
Well, I certainly won't argue that gold can't move higher in the coming months, but I believe a big part of what is driving the gold rush is fear and uncertainty over the global economy's prospects. While gold can be an excellent short-term hedge against inflation and economic turmoil, it simply hasn't held its value as a long-term investment. There may be room for this metal to run yet, but I think a lot of investors are going to get burned by buying in at the wrong times.
People are jumping on the gold and commodity bandwagon now simply because they've seen how well these areas have performed, and that's a clear danger sign. Look for more money to head into these types of funds as investors try to make up lost ground in their portfolios. Fortunately, we know that performance-chasing simply isn't an optimal way to invest.
However, if you feel you absolutely must include commodities in your fund lineup, keep your allocation very small and be ready for wild swings, both up and down. Or consider buying one or two reasonably priced mining stocks with great long-term outlooks, like Yamana Gold (NYSE: AUY ) or Agnico-Eagle Mines (NYSE: AEM ) . Just remember that commodities are risky and are not the way to get your portfolio back to where you were a few years ago.
No doubt other mutual fund trends will emerge in 2010, some of which will be downright dangerous for the average investor. But by keeping a long-term focus and avoiding chasing trends, investors can keep a level head and keep their portfolio safe this year and beyond.