By Gary Stringer, Kim Escue and Chad Keller, Stringer Asset Management
In the past, many Financial Advisors saw little value in actively managing fixed income. All one had to do was build a bond ladder based on the available inventory of high quality bonds and earn 6%. When a bond matured or was called, roll it to another bond and earn 6% again.
Obviously, the world has changed as interest rates have fallen dramatically. What is less well known for many, is that risks have spiked at the same time that yields have fallen. The collapse in yield has led to a corresponding increase in both interest rate risk and credit risk.
In the old days, increasing yield often meant simply using longer-dated maturities or moving down the quality ladder toward high yield bonds, or both. And again, clip the coupon, roll the paper, and earn a sufficient return.
The fixed income landscape today is very different. Simply employing either or both of those approaches may lead to outsized risk, significant volatility, losses, and headaches.
Paying More To Get Less
If risk is the price of return, then today’s fixed income market makes quite the conundrum for investors. For example, as the following graph shows, while the interest rate on the Bloomberg Barclays Aggregate Bond Index has declined since 2000, interest rate risk, as measured by duration, has spiked nearly 30%. This is just a function of the math involved with bonds. For the same maturity date, a lower coupon bond will have higher interest rate risk than a higher coupon bond, all else being equal.
Similarly, one cannot just move down the credit quality spectrum to pick up a little more yield as one could in the old days. While interest rates have declined across all sectors of the bond market, the extra compensation that investors could reap for moving down the credit quality spectrum has declined further. Thus, declining absolute interest rates, combined with declining interest rate spreads, is like adding risk on top of the other risks.
NAVIGATING THE MINEFIELD
We think that this market offers opportunities for actively managing fixed income assets through a process that puts risk first. Our Risk First approach has historically helped us sidestep shocks to the bond market, such as last fall’s interest rate spike. By putting risk first, and seeking relative value opportunities, our strategies have generated a healthy current yield while still helping to preserve capital.
We achieve this by managing interest rate and credit risk, while casting a wide net when seeking opportunities in both the traditional and non-traditional fixed income arenas. Outside of the traditional Bloomberg Barclays Aggregate Bond Index sectors, such as U.S. Treasuries, investment grade corporate bonds, and agency mortgagebacked securities, we are finding a host of return enhancing and risk management opportunities further afield. From broadly diversified ETFs that blend allocations to REITs, MLPs, dividend-paying equities, and corporate bonds, to more focused, outside of the mainstream holdings, like convertible bond ETFs, high yield municipal bond ETFs, ETFs focused on preferred stocks, and high quality floating rate fixed income ETFs.
One key to successful portfolio management, both within the traditional fixed income spectrum and outside of it, is to appropriately balance the potential risks associated with each of these investments. So, how should you navigate the fixed income minefield? Contact Stringer Asset Management for more information: firstname.lastname@example.org.
Any forecasts, figures, opinions or investment techniques and strategies explained are Stringer Asset Management LLC’s as of the date of publication. They are considered to be accurate at the time of writing, but no warranty of accuracy is given and no liability in respect to error or omission is accepted. They are subject to change without reference or notification. The views contained herein are not be taken as an advice or a recommendation to buy or sell any investment and the material should not be relied upon as containing sufficient information to support an investment decision. It should be noted that the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Past performance and yield may not be a reliable guide to future performance. Current performance may be higher or lower than the performance quoted. The securities identified and described may not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in the securities identified was or will be profitable. Data is provided by various sources and prepared by Stringer Asset Management LLC and has not been verified or audited by an independent accountant.