For fixed income investors, it’s time to review your strategy …”as bonds’ golden age comes to an end.”1 At least that’s what a recent article in the Financial Times proclaims. The story points out how the unique “circumstances that produced that golden age for bond returns — falling inflation, surplus savings and the rest — will not be repeated…” And we could not agree more.2
Indeed, with government debt levels soaring and nothing but partisan bickering about budget deficits coming out of Washington these days, investors have good reason to be worried about the specter of inflation in the not-too-distant future.
Look, if you can be certain of anything in today’s turbulent markets, it’s that interest rates and inflation are eventually going to move higher from near-record low levels now.
It is only a question of timing.
Of course, when yields go higher, bond prices go lower. And if you’re holding a portfolio full of long-term bonds during a rising rate climate, you face a potential loss of principal … not to mention purchasing power if inflation rises faster.
What can you do about it?
In this editorial, we’ll share some ideas about fixed income alternatives we’re using in client portfolios … alternatives that we call bond surrogates. We’re convinced these alternatives can not only boost current income, but also offer some protection from rising interest rates in the future for the investor with a moderate risk tolerance.
But first, let’s take a look back to give us a better idea of what may be in store for interest rates in the years ahead…
Editor’s Note: For a FREE copy of our report on Bond Surrogates, go here now.
A Study of Past Bond Market Cycles Reveals Trouble Ahead
Since 1926, the return on intermediate-maturity Treasury bonds has averaged 5.3 percent annually. Most of this return … over 90 percent … has historically come from coupons — or the stated yield investors received.3
Today’s coupon yield for newly issued 10-year Treasury notes is only about 3.6 percent. That’s quite a bit less than the average annual return of 5.3 percent historically.
What this means is that investors in 10-year bonds today must rely on a lot of price appreciation potential to produce just average returns going forward. How likely is that?
We don’t think it’s likely at all for a very important reason: The grand bond bull market that started in 1981 is just about over … if not extinct already.
The late, great bond bull market began from a favorable starting point for bond investors. Treasury yields peaked at 16.1 percent in August 1981 — ah, the good old days.4
Editor’s Note: For a FREE copy of our report on Bond Surrogates, go here now.
From such lofty levels, there was almost no place for yields to go but DOWN and for bond prices to go UP. And sure enough, bonds returned an average of nearly 9 percent annually over a nearly 30-year period that followed the interest rate peak.5
A significant tailwind pushing bond returns higher during that period was steadily falling inflation and interest rates.
But today, this tailwind has turned into a hostile headwind for bonds. And with Treasury yields at such low levels, the upside appears a lot more limited.
Now let’s go even further back in time, to the last secular bear market (or down trend) in bond prices from 1941 to 1981.
Interest rates and inflation were rising during this period. As a result, investors in intermediate maturity Treasury bonds earned a yearly total return of just 3.3 percent as bond prices fell about 1 percent per year, which ate into income gains of 4.4 percent annually!6
This secular bear market in bonds more than half a century ago is perhaps a better model for what could happen in the years ahead. Some savvy investors aren’t waiting around for this scenario to play out …
Editor’s Note: For a FREE copy of our report on Bond Surrogates, go here now.
Bill Gross SHORTING Bonds: Should You?
Bill Gross, manager of the world’s largest bond fund, Pimco Total Return, created a stir last month when it was revealed he had dumped ALL US Treasury bond holdings from his portfolio — nearly $30 billion worth — in just one month.7
But heads really turned last week when Pimco disclosed Gross is now betting against US government debt. The $236 billion fund Gross runs is now NET SHORT Treasury bonds to the tune of about $7 billion, while raising cash to the highest level in four years.8
When the “bond king” himself turns bearish on bonds … it’s a warning worth taking seriously.
What’s our solution? There are two steps you should consider …
First, we’ve been proactively shortening the average duration of our Banyan fixed income portfolios to about four years or less. This measure tells you how long it takes — on average — to be repaid your principal assuming no default.
With shorter durations, you’ll get your money back sooner, giving you the potential to reinvest at possibly higher yields as interest rates rise in an inflationary climate. By investing in a diverse mix of taxable and tax-free bonds, we’re currently earning average yields of 5 to 6 percent with an average duration of less than four years.
Second, to earn even more current income in today’s low yield market, we also recommend that you look beyond conventional bond holdings. Instead, consider adding fixed-income surrogates to your portfolio.
These bond-like investments can offer not only higher current yields now, but the potential for a growing income stream over time and capital appreciation .
We’re anticipating a higher interest rate climate ahead and even though the potential for 1970s style runaway inflation may be overstated, we aren’t waiting around to find out. Instead, we’re already taking proactive steps within our client portfolios to prepare for rising rates well ahead of time.
Editor’s Note: For a FREE copy of our report on Bond Surrogates, go here now.
Seeking Shelter from Rising Rates: 3 Options to Consider
At Banyan Partners, we tackle interest rate, inflation and credit risks up front by customizing each bond portfolio to meet the specific income needs of each client. But if you’re doing it yourself, you’ll need to take a more opportunistic approach to your income investments that can help you preserve capital in a shifting interest-rate climate.
You may also want to take a closer look at fixed-income surrogates as an important option to consider right now:
Option #1 – Asset Backed Equities: A handful of America’s biggest energy companies have a unique advantage: The US government gives the income they generate huge tax breaks. In exchange, these companies are required to pay out nearly all profits to shareholders annually in the form of dividends.
Barron’s has said this asset class "could be the decade’s quietest investment success." That’s because these companies have outperformed the S&P 500 by a margin of nearly 7-to-1 in total return over the past 10 years, on average!9
We’ve just published a new report: Better Than Bonds: The Banyan Guide to Fixed Income Surrogates, which includes more detailed research and analysis on these bond surrogates.
Option #2 – Emerging Income Funds: Some of the best income-producing opportunities today aren’t even in US markets, but are found internationally. If you look beyond our borders, you’ll find many countries AND companies that are:
- Healthier than the US economically …
- With stronger currencies than the US dollar …
- And offer higher interest rates than you can find in US markets.
If you’re selective, you’ll have the opportunity to earn higher income while at the same time hedging against further depreciation of the US dollar by taking a more global approach to your investments. It’s all included in our report.
Option #3 – Dynamic Dividend Plays: Another income option you’ll learn about: A small group of high-quality stocks with attractive yields and a consistent track record of steady dividend growth over time. This list of companies has increased dividends every year for a minimum of 25 years. In fact, one of these companies has paid consistent dividends each and every year since 1916!
If you’d bought this dynamic dividend play just 10 years ago, you could have already received one-third of your original investment back in dividends alone … PLUS your effective yield would have doubled along the way. That’s not including your capital gains as the share price doubled in 10 years.10
Bottom line: If you’re an income-oriented investor with a moderate risk tolerance, now may be the right time to take a closer look at your portfolio and consider alternatives to traditional long-term bonds, including bond surrogate securities.
We’re not suggesting that you rush out and sell all your bond holdings. After all, bonds can provide important benefits, including diversification and lowering your overall volatility if you also own stocks. Bond surrogates may not be the right fit for every investor’s portfolio as they have unique risks of their own to consider.
But now could be an excellent time to review your portfolio, with an eye toward shortening your overall maturity, and see if there’s a place for these income alternatives in your portfolio.
I invite you to find out for yourself by going here to get a free copy of this report.You may find new opportunities you haven’t considered to boost your income … enjoy growing yields … and help protect your wealth from the threat of inflation.
Good investing,
Mike Burnick
P.S. Income investors face several threats from a shifting interest rate climate, but there are alternatives. There’s never been a better time to learn about bond surrogates. Get a copy of our just-published report: Better Than Bonds: The Banyan Guide to Fixed Income Surrogates, by go here now!
All opinions expressed herein are subject to change without notice. This report is not a complete analysis of every material fact with respect to any company, industry or sector mentioned in this report.
The concepts discussed in this newsletter may not be appropriate for all investors. Investors must make their own decisions based on their specific investment objectives, risk tolerance, and financial circumstances. This report is solely for informational purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Past performance is no guarantee of future results. Investments that are concentrated in a specific sector or industry may be subject to a higher degree of market risk than funds whose investments are more diversified.
Please contact us at www.banyanpartners.net to receive our disclosure document, ADV Part II, for a full description of our services, including fees and expenses.
1 Financial Times: Hard and Fast Rules Should be Treated with Caution, 3/7/11
2 Ibid.
3 FMRCo (MARE): Bonds: Lower Yields, Lower Expectations, 3/2/10
4 Ibid.
5 Ibid.
6 Ibid.
7 Wall Street Journal: Pimco’s Gross Dumps Treasuries, 3/10/11
8 Bloomberg: Pimco Cuts Government Debt to Negative, Boosts Cash, 4/11/11
9 JPMorgan: Alerian MLP Index ETNs, 3/8/11
10 Standard & Poor’s, data as of 3/5/11
No comments:
Post a Comment
Note: only a member of this blog may post a comment.