Thoughts from Our Fixed Income Team
It has been, and will continue to be, a challenge: finding anything resembling the attractive yields of olde without assuming undue levels of risk.
U. S. nominal interest rates remain stuck on historical lows. The yield spreads between government and corporate issues are tight. And following a prolonged period of ‘risk-on’ sentimentality, the premiums investors are willing to receive for all sorts of uncertainty are bouncing along the lowest levels in memory. Official Federal Reserve policy, adding fuel to the problem, is underpinning this situation with near-zero short-term rates for as far off as one dares to peer. What can fixed income investors do with safe monies as even BBB-rated corporate bonds fall to 4.0% yield levels? Nothing’s ever easy, but really!
Fortunately, two time-honored strategies remain as helpful as ever. Even with ongoing pressure from continuing (who knows how long) Federal Reserve purchases of longer-dated Treasury and mortgaged-backed securities, a positively-sloped yield curve persists and offers opportunities to enhance anemic market yields to more palatable levels. Commonly referred to as “riding-the-yield-curve”, purchases made at strategic maturities and held for defined periods may benefit a portfolio in key future ways. Reflecting the lower yields matched to shorter maturities of the same issuer, market prices may rise relative to original prices paid over time and add valuable overall performance. Assuming general rate levels and the shape of the curve remain constant, such a strategy in the current environment can potentially double total returns over a twelve-month holding period than what is suggested by a security’s current yield to maturity. Well, at least it’s a start.
Moreover, productive active management will become a more significant determinant of a bond portfolio’s actual future performance than entry level yields, especially so if yields remain so low. Over the course of a fixed income holding in a portfolio, from initial investment to maturity or liquidation, there are numerous opportunities to improve overall portfolio characteristics by replacing one security with another higher yielding or less-risky alternative. Yield-to maturity calculations (determined at the time of purchase) are based only upon temporary assumptions which may or may not prove eventually accurate. Strategic replacement, or “bond swapping”, seeks to enhance returns, reduce risks, or ideally achieve both objectives with a more practical eye on mathematical improvements.
In any case, riding-the-yield-curve and active portfolio management, traditional bond management strategies, may prove considerably more productive over the longer-term than blindly grasping for the highest remaining stated coupons on the market’s sale table. And you may also get to sleep better in the bargain. In addition, unknowingly forgoing safety for illiquidity (the market’s current carte du jour) or sacrificing individual ownership of your investments for commingled pools of less-regulated derivative instruments may ring warning bells from the not too distant financial past. What’s more dangerous than a risky investment? Answer: One that’s leveraged. Remember?
Submitted by: Howard Potter – Senior Fixed Income Portfolio Manager
This information is intended solely to report on investment strategies and opportunities identified by Roosevelt. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. References to specific securities and their issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Please contact us at 646-452-6700 if there is any change in your financial situation, needs, goals or objectives, or if you wish to initiate any restrictions on the management of the account or modify existing restrictions, or if you would like to request a copy of our Code of Ethics. Our current disclosure statement is set forth on our Form ADV Part II, available for your review upon request, and on our website, www.rooseveltinvestments.com.