Experts have theorized that a "great rotation" out of bonds and into other investments (primarily stocks) was likely to occur once interest rates began to rise. The bond market was a good place to be while interest rates steadily fell after Paul Volcker subdued inflation by raising the Fed Funds rate to an astounding 20% back in the early 1980s. The current Fed Funds rate, which is somewhere between 0% and 1/4%, is at its lowest level ever.
Great rotation theorists believe that rising interest rates, a scaling down of the Fed's quantitative easing program (commonly referred to as "tapering") or just the threat of tapering could incent bond fund investors to liquidate their holdings and look for other, more promising investments. It is thought that the bulk of the funds coming out of bonds could find their way into stocks.
For a number of years the great rotation was just a theory. However, last week The Wall Street Journal reported that the Vanguard Total Stock Market Index Fund has now become the largest mutual fund in the world. Ever since the crash, the PIMCO Total Return Fund (an intermediate term bond fund) had been the largest mutual fund. This change could signal that the great rotation is underway.
How should retirement plan participants be advised to react to the great rotation? They should:
• Continue with their allocations to fixed income. The diversification benefits of the fixed income asset class and its lack of correlation with the stock market are important in any portfolio.
• Consider international bond funds, multi-sector bond funds and absolute-return bond funds as opposed to intermediate term bond funds and government bond funds.
• Not try to time the market by shifting assets significantly from bonds to stocks in an attempt to take advantage of what appears to be an opportunity.
• Keep in mind that retirement plan accounts are long term investments. Every effort should be made to avoid "trading" 401(k) plan accounts.
Traditional fixed income investments (like intermediate term bond funds) may provide disappointing returns in a rising interest rate environment. It may be wise to include in your 2014 employee education sessions a discussion of what the great rotation means to 401(k) plan participants.
Contributing Editor Robert C. Lawton is President of Lawton Retirement Plan Consultants, LLC a Registered Investment Advisory firm helping retirement plan sponsors with their investment, fiduciary, employee education and compliance responsibilities. Mr. Lawton has over 25 years of experience working with corporations on their retirement plans and is a Chartered Retirement Plan Specialist (CRPS) and Accredited Investment Fiduciary (AIF). Mr. Lawton was named as a Top 100 Retirement Plan Adviser by PLANADVISER and a Top 300 Retirement Plan Adviser by 401(k) Wire. Mr. Lawton may be contacted at
