By Chuck Jaffe, MarketWatch
4. Disappointed bond fund investors:
It’s not a surprise that stocks have outgained bonds over the last five years. The bigger issue is that the 10-year Treasury /zigman2/quotes/211347051/realtime BX:TMUBMUSD10Y -3.40% low hit in July 2016 has been cited by several experts as the potential end for a bond bull market that has run for 35 years.
While bond funds will not crater this year as rates rise — something experts were worried about a few years ago — bond-fund returns are not likely to keep up with recent levels of success.
5. A big increase in unpleasant tax surprises:
The rally in late 2016 helped push back a tax problem, but unless the market is stronger than anticipated and volatility is lower than expected, funds are going to generate large taxable distributions as they react to changing market conditions.
Distributions don’t feel like a problem in good years when funds post big gains and taxes feel like a cost of doing a profitable business.
In a market reversal, decline or a flat/low-single-digit year, however — and especially if increased volatility pushes managers to sell into apparent trouble — funds may generate tax bills that equal or eclipse their growth; investors won’t be happy with oversized tax bills on mediocre results.
6. The 10-year flat-line:
With most investors focused domestically, it has been easy to ignore the fact that foreign markets could get to the end of this year and wind up showing a lost decade, a 10-year stretch where the average fund was flat or down, on average, since before the financial crisis started.
Look at a 10-year chart on emerging markets, for example, and it’s clear that if the average fund can’t put up gains of about 25% by the end of October, the entire asset category will be showing a decade when it was under water.
Accordingly, when people preach to “buy domestic” this year, a big weapon they will be using come the fall is the talk of a lost decade in some international markets.
7. Investors give up on diversification at just the wrong time:
Over the last few years, allocating assets across different investment types hasn’t really worked; investors would have benefitted mostly from keeping the bulk of their holdings in big domestic stocks.
That has led to frustrated investors moving away from the traditional diversified portfolio to a factor-investing approach, which typically means they are pursuing whatever has worked lately.
The one certainty for 2017 is uncertainty; fallout from the U.S. presidential election and the Brexit vote in Great Britain — and political nervousness around the world — hasn’t really hit home yet. It might turn out good or bad, but it won’t show up in markets until late in the year. Meantime, there is substantial headline and volatility risk, and diversification helps to soothe those savage beasts … provided you stick with it.