Date: October 2012: Backing Off from Bonds - Barrons.com

Raj Sharma has a particularly good vantage point these days, and not just because of the expansive views from his 24th-floor office in downtown Boston. Having grown up in India, Sharma has a direct, before-and-after view of emerging economies. "I see what is happening with friends of mine and people I grew up with, who are doing so well. You would be amazed at the level of activity and the sheer optimism" in emerging markets, he says. "That wasn't there 25 or 30 years ago."

The 55-year-old financial advisor was a young disc jockey in India before moving to the U.S. in 1980. After a stint in advertising, he joined Merrill Lynch in 1987, two months before Black Monday. Sharma has been with Merrill ever since. This year, he ranked 26th on Barron's list of Top 100 financial advisors. His nine-person team advises 100 families, with a typical account size of $10 million.

From the early days, Sharma built his practice by focusing on clients from the ranks of executives in Boston's thriving biotech and software communities, graduates of the city's leading medical and engineering schools. Tech and science still influence his practice, and medical and technology-based executives still make up 60% to 70% of his client base, he says.

BUT IT'S HIS INTERNATIONAL BACKGROUND that chiefly drives Sharma's views today. He makes a compelling argument for emerging markets, which now comprise about 85% of the world's population. "You've got the developed markets, which have high debt, high deficits, low savings, and a wave of deleveraging coming our way," says Sharma, sounding very much like an economics professor. "Deleveraging essentially means less spending, less growth, low interest rates, and low asset-price returns for a long time to come.

"On the other hand, you have emerging markets that have little debt, high savings, budget surpluses, and a population that is getting more and more affluent."

The bottom line, Sharma says: The next washing machine is more likely to be bought by someone in Beijing than in Boston.

He's advising clients to buy emerging-market debt that's denominated in local currencies, along with emerging-market equity funds that go beyond the typical BRIC (Brazil, Russia, India, and China) allocation. Sharma uses various exchange-traded funds and mutual funds for that exposure.

Merrill Lynch policy prevented Sharma from discussing specific current investments, but investors looking to play these themes have plenty of ETFs to choose from. Among the lowest-cost options are Vanguard MSCI Emerging Markets fund (VWO), a broad-based play, and Market Vectors EM Local Currency Bond fund (EMLC).

Sharma says emerging-market stocks offer a "generational opportunity," with the sector trading at less than 10 times projected earnings for next year. The slow-growing developed world fetches a premium, at 12 times forward earnings. Sharma thinks it's only a matter of time before the emerging-market multiple catches up with, and exceeds, that of the developed world.

The advisor is pushing clients to step out of other comfort zones. He warns that the traditional 60/40 allocation—60% stocks and 40% bonds—no longer works. And he's perplexed by the fact that fund flows still show investors favoring debt over equity.

"I think we are in the midst of a silent bond bubble," he says. "I'm really fearful for the investor who has put so much money into bonds without really understanding the interest-rate risk."

WITH 60/40 OBSOLETE, SHARMA says investors need to rethink asset allocation and classifications. He uses four buckets that he labels safe, fixed-income proxy, equity/total return, and alternatives, representing 30%, 30%, 25%, and 15% respectively.

He is interested in income regardless of source, so his fixed-income-proxy category is a hybrid approach, including dividend-paying equities and master limited partnerships, on top of floating-rate bonds, mortgage-backed securities, and emerging-market debt.

When it comes to executing the strategy, Sharma and his team are obsessive about rebalancing. They shift around funds whenever allocations deviate too far from pre-established parameters. If done properly, Sharma says, rebalancing is the "last free lunch on Wall Street," forcing investors to sell high and buy low.

Sharma has plenty of advice to dispense to clients, but rebalancing gets to the crux of it all: Come up with a plan, and stick to it. Emotion can ruin even the best of portfolios. 

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