Businessman’s hand showing unbalance between facts and myths on wooden seesaw
It’s a line you’ve no doubt heard before. It goes like this: “The market is too efficient to beat, so you may as well just park your cash in a low-cost index fund and call it a day.”
Nonsense! The truly ridiculous thing is, this myth is proven wrong every day—but investors just can’t quit it. And it’s costing them triple-digit returns (and 7%+ dividends) that could leave them well short of what they need to retire.
For proof that this market is far from efficient, just look at the one-day 22% drop in shares of Beyond Meat (BYND). That came after the company beat revenue expectations and its profits were twice what the market expected.
Markets get even less efficient (and easier for us to tap for 7%+ dividends and market-crushing upside) when we go beyond stocks, to areas like preferred stocks and corporate bonds.
There, human managers have the edge, and for them, crushing the benchmarks is a piece of cake. Take PIMCO’s Corporate & Income Strategy (PCN), a closed-end fund (CEF) from one of the biggest CEF managers in the space.
Off the bat, PCN gives us a generous 7.2% in dividends, but there’s more: it racked up a 316% return in the last decade, crushing not only corporate-bond funds like the Vanguard Total Bond Market ETF (BND) and SPDR Bloomberg Barclays High Yield Bond ETF (JNK), but the stock market itself!
If this doesn’t put the “efficient market” myth to bed, I don’t know what does! Notice that the bond benchmarks (in red and yellow) badly trail the stock market, yet PCN’s human managers have more than tripled their return over a decade by investing in the very same assets.
Mainstream Investors Catch On
With a chart like that, it’s easy to see why, when it comes to bonds, actively managed funds win out. And the mainstream crowd is getting the hint. In 2019, stocks are up over 20%, thanks to a broad recovery from 2018’s panic selloff.
But the part that might surprise you is that more cash has been flowing into actively managed bond funds than into passive equity funds.
Contrarian Outlook
According to Lipper Funds, equity ETFs have seen less than $50 billion in net inflows, while the $147.6 billion of inflows into all kinds of ETFs is less than the $227.5 billion in total net inflows to bond mutual funds.
Let me show you why this seemingly obscure fact is crucial to your financial situation now.
ETFs are dominated by passive index funds, while most conventional funds (mutual funds, CEFs and the like) are actively managed. What’s more, on the stock side, the largest inflows have gone to popular index funds like the Vanguard 500 Index ETF (VOO), which has seen $11.5 billion in inflows, and the Vanguard Total Stock Market ETF (VTI), which has attracted $8.4 billion of inflows.
These two funds alone represent nearly half of all the inflows into equity ETFs (include the other index funds and it’s almost all of the nearly $50 billion of total inflows to equity ETFs). The bigger inflow to equity ETFs and the huge drop in inflows to equity mutual funds (which you can also see above) tells a clear story: with stocks, the market favors passive index funds.
But notice how the market prefers actively managed funds for corporate and municipal bonds (shown as “tax-exempt bond funds” in the chart above)? If the market is efficient, it’s acknowledging that it isn’t efficient enough to win in the world of bonds—and so it’s relying more on human-managed funds like PCN to drive returns.
So what’s the bottom line here?
As you diversify your portfolio—a wise move with stocks at all-time highs—consider actively managed CEFs like PCN for your bond holdings. With these funds throwing off income streams of 7% or more, you’ll not only crush the market, but you’ll get paid very well to do so.
Michael Foster is the Lead Research Analyst for Contrarian Outlook. For more great income ideas, click here for our latest report “Indestructible Income: 5 Bargain Funds with Safe 8.5% Dividends.”
Disclosure: none