| Bonds Online |
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| 5/10/2013Market Performance |
| Municipal Bonds |
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S&P National Bond Index
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3.00% |
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S&P California Bond Index
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2.96% |
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S&P New York Bond Index
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3.13% |
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S&P National 0-5 Year Municipal Bond Index
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0.70% |
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| S&P/BGCantor US Treasury Bond |
400.09 |
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| Income Equities: |
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| Preferred Stocks |
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S&P U.S. Preferred Stock Index
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848.03 |
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S&P U.S. Preferred Stock Index (CAD)
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636.26 |
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S&P U.S. Preferred Stock Index (TR)
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1,701.05 |
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S&P U.S. Preferred Stock Index (TR) (CAD)
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1,276.26 |
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| REITs |
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S&P REIT Index
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174.07 |
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S&P REIT Index (TR)
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425.30 |
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| MLPs |
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S&P MLP Index
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2,469.58 |
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S&P MLP Index (TR)
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5,428.50 |
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See Data
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Investment Insights: The importance of bonds in portfolios today |
TheJournalTimes.com - Aug. 26, 2010 - by Arthur Rothchild
Given continued volatility in global stock markets, it is nice to know that bond investors have been able to benefit from ongoing interest payments and the relative stability that the bonds in their portfolio have provided this year. I am hopeful that the insights below will benefit investors who would like to learn more about opportunities available in bonds today
Types of bonds and bond funds
For those who are not familiar with this subject, I will start with a few simple concepts. A "bond" is simply an instrument that signifies a loan by a consumer or institution to another institution. For example, the Federal government issues Treasury bonds which investors buy thereby loaning money to the Federal government. States and municipalities issue "municipal" bonds which investors buy thereby loaning money to states and municipalities. Corporations issue "corporate bonds" which individuals and other institutions buy thereby loaning money to those corporations.
Bonds are issued for different periods of time, generally starting at one year. Bonds can carry set interest rates or rates that can vary over time. Issuers' creditworthiness will determine how a particular bond is "rated" and the "credit rating" of the particular issuer or offering will determine the interest rate the lender will receive and the borrower will have to pay.
When bonds are packaged into pools and distributed to the public in quantity, either actively managed, or sometimes managed to mimic a particular index, the grouping into this package is referred to as a "fund." Funds come in various types, from "closed end" or "exchange traded" to the more commonly referenced "open-end mutual fund."
How bonds fit in most portfolios
Bonds and bond funds are commonly used by investors to provide a predictable income stream, some level of certainty as to the return of principal (one's original investment) and as a buffer to mix with stocks to provide "insulation" in long-term portfolios. Municipal bonds are useful for high income taxpayers in deriving a higher "after-tax return" than might otherwise be achieved from investing in "taxable bonds." Foreign bonds and bond funds can be used to provide a hedge against the potential decline in value of U.S.-based investments. Taxable bonds, particularly in qualified retirement accounts, can provide a fairly high "yield "(income) for current or future distribution in retirement.
The use of bonds today
I had a call today from a client I have been working with for over fifteen years. This investor has a preference for owning individual stocks and bonds. He uses me as a resource to assist in determining appropriate courses of action and in filling the gaps which periodically arise in his portfolio. This investor is knowledgeable, experienced and confident. Pursuant to his request we searched for bonds which had a very high credit rating and could provide a yield in the 5 to 6 percent range for the next 10 to 15 years. I was pleased to find a significant number of issues meeting these criteria for this particular investor.
Unlike this investor, most would rather have the protection that comes from acquiring bonds through actively managed mutual funds. For example, for another client, I acquired three types of funds for the purposes of income and capital preservation in his individual retirement account. I used one fund that specializes in very high quality corporate and government bonds, one that invests in a broader universe of bonds from overseas as well as domestic issuers and another that invests in higher yielding bonds as well as in stocks of companies known for their increasing dividend distributions. Once again, this mix is anticipated to provide the client with income or "yield" in the five percent range.
For another relatively young client in a high tax bracket, we monthly acquire shares in a "municipal bond fund" that helps him accumulate a portfolio of "relatively safe" bonds sheltered from federal taxes. For yet another client I periodically purchase individual municipal bonds to fill in the rungs of their "bond ladder" as other bonds mature.
Risks of bonds and bond funds
Any consumer, whether managing their own portfolio, or working with a professional, should be aware of the risks inherent in bond and bond fund investing as well as the costs they should expect to incur in their acquisition and maintenance.
First and foremost bonds and bond funds should never be acquired simply on the basis of their high "yield" or distribution rate. Higher yields are generally reflective of lower credit quality. Higher yielding or "junk" bonds should not necessarily be shunned, but should only be acquired by knowledgeable investors who purchase them after comprehensive research as part of a well diversified portfolio. In my practice I never buy individual "junk" bonds. I do, however, employ managers who are able to "sift through" the many lower quality high yielding issues available for those that will provide a relatively safe higher yield and possibly capital appreciation. In this case, we are protecting against the loss of principal and this is referred to as "default risk."
As U.S. Treasury bonds are perceived to have the highest quality, they correspondingly have the lowest yields. I do not purchase individual treasuries but prefer to employ managers who use Treasuries and U.S. Government agency issues in funds that can provide higher yields than I would otherwise be able to obtain through individual issues while again diversifying the portfolio among different "maturities."
When a bond matures will also influence how much the investor will receive in interest. Generally the longer the "maturity" of a bond the higher will be its yield. When interest rates fluctuate the values of bonds also fluctuate. When interest rates go up the value of bonds of longer maturities go down more than those with shorter maturities. Likewise when interest rates decline, the longer the maturity of a bond the more the value of the bond increases. Individual investors and professionals alike manage the risk of potential loss due to interest rate increases by controlling the "average duration" of their portfolios.
Another risk municipal bond investors assume is the possibility of the default of a particular municipality or a "revenue" project a particular bond has been issued to fund. This risk can generally be minimized by selecting "higher rated" municipals and further by investing in higher quality municipal funds.
Investors in foreign or global bond funds have to be attuned to risks associated with bonds issued in currencies other than the U.S. dollar. In cases where those foreign currencies decline in value relative to the U.S. dollar, the investor can experience declines in the value of his investment. Conversely, the same investor could benefit when those currencies increase in value relative to the U.S. dollar. Likewise investors in foreign governments and firms can oftentimes obtain higher interest payments or "yields" than would otherwise be obtainable by making comparable investments exclusively in the U.S.
Advice today
A significant amount of attention is being given to the Federal Reserve and their effort to support a very weak domestic economy. Most recently, their announcement that they would be purchasing more treasury bonds has caused the value of those types of bonds to increase and their yields to decline correspondingly. More and more often investors are being made aware of the very low likelihood of inflation in the immediate future and greater likelihood of deflation.
Rather than being a negative environment for bond investors, some feel that this could actually be a particularly good one for investors in both corporate and U.S. Government issues. As indicated above, my preference for most investors are funds managed by the best available bond managers who can anticipate and adjust those portfolios as the winds of change are anticipated or begin to blow. Municipal investors also have the opportunity to participate in what are still some tremendous opportunities, particularly if they are willing to move further out in their maturities. Again, they should carefully select only the best issuers in case further economic difficulties cause some of the weaker jurisdictions and projects to encounter difficulties in meeting their obligations.
Arthur S. Rothschild is a vice president of Landaas & Co. Investment Services. Your comments or suggestions for future articles are welcome at (800) 236-1096 or by e-mail to arothschild@landaas.com
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