2008 proved to be a veritable nuclear winter for all investment asset classes except U.S. Treasury bonds. The ongoing, massive world-wide flight to safety has rendered retired investors bewildered and struggling to find true safety and reasonable rates of return.
Investors are wondering if Treasuries will be king of the hill again in 2009. Not likely, according to Mohamed El-Erian, Chief Investment Officer at Pimco, who recently advised investors to "Get out of Treasuries. They are very, very expensive." Andrew Bary punctuated that same sentiment in Barron'sexclaiming, "A flight to safety has created a bubble in Treasury bonds. Get out now!"
If Treasuries are indeed priced at "bubble" levels, what investments might provide relief to beleaguered retirees in search of capital safety and higher investment income in 2009? A growing number of professionals suggest the following three asset classes may indeed fill that bill.
- Mortgage Backed Securities
- Treasury Inflation Protected Securities (TIPS)
- Municipal Bonds
Mortgage Backed Securities
Yields on mortgage backed securities (MBS) have been declining ever since the Fed's November 2008 announcement that it would purchase up to $500 million of Ginnie Mae, Freddie Mac (FRE) and Fannie Mae (FNM) home mortgage-related bonds. But with the first purchases just beginning last month, current yields of these battered securities still look quite attractive by historical standards. Additionally, with the Fed's intervention, mortgage backed securities now offer effectively the same Federal guarantee as U.S. Treasuries, but with higher yields. Consider iShares Barclays MBS Bond Fund (MBB), iShares Barclays Agency Bond Fund (AGZ) and SPDR Barclays Capital Mortgage Backed Bond ETF (MBG).
Treasury Inflation Protected Securities
There is little doubt that fears of inflation have recently shifted to forecasts of accelerated economic de-leveraging and to the growing risks of worldwide deflation. This reversal in sentiment has sent TIPS into a dive, driving yields higher. The probable likelihood over the next several years, however, is that burgeoning Federal stimulus programs will lead inflation higher, perhaps rivaling the late 1970's, when inflation peaked above 14%. TIPS will thrive as inflation heats up.
According to Bill Gross, in a January 19, 2009 Barron's interview, investors can expect TIPS to pay off big in the next six months, as the de-leveraging cycle begins to slow. He explained that TIPS "can go up 10% to 20% in price, simply on the basis of optimism that deflation has been averted." Take a careful look at iShares Barclays TIPS Bond Fund (TIP). Also, consider SPDR Barclays Capital TIPS (IPE).
Municipal Bonds
Tax-free municipal bond yields hit historical highs in November 2008 fueled by hedge funds which were unwinding leverage in the highly liquid "tender-option bonds" market. Although prices have recovered and yields have waned recently, municipals still offer remarkable value compared to U.S. Treasuries.
Even in this current era of growing revenue shortfalls by state and city governments, defaults by investment grade municipals are rare. During the Great Depression, municipal defaults averaged less than 3%.
With today's 3-4% tax free distribution rates, investment grade municipals look like a bargain (a 4% tax free yield for a taxpayer in the 35% Federal tax bracket is the taxable equivalent yield of a Certificate of Deposit or Treasury bond paying 6.2%).
Municipal Bond ETFs worth considering include Power Shares Insured National Municipal Bond Portfolio (PZA), iShares S&P National Municipal Bond Index Fund (MUB) and SPDR Lehman Municipal Bond ETF (TFI).
For Californians who believe Gov. Arnold Schwarzenegger will eventually "terminate" California's rising deficits, the iShares S&P California Municipal Bond Fund (CMF) looks like a good bet. Additionally, Tom Lydon, the California based Editor of "ETF Trends", astutely points out that President Obama intends to direct much of the $790 billion stimulus package to infrastructure spending at state and local levels.
For the ultimate in credit safety, look at the newly launched Market Vector's Pre-Refunded Municipal Index ETF (PRB). PRB is the first ETF investing 100% in "pre-refunded" Municipal Bonds. Pre-refunded municipals are issued to pay off existing, high-rate bonds. These "pre-res" are fully collateralized by U.S. Treasury securities, making them the only municipal bond class 100% fully guaranteed by the U.S. government.
Other Safe Investments
Two additional asset classes that income oriented investors should investigate are senior loans and preferred stocks. But for now, your best bets for principal safety and steady income are mortgage backed securities, Treasury inflation protected securities and tax-free municipal bonds.
