| 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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Taking Cover: Where to Hide if Bonds Fall |
THE WALL STREET JOURNAL - Oct. 13, 2009 - by Larry Light
What goes down must come up. So how should investors protect themselves when interest rates rise again?
With rates currently low, investors have been stampeding out of money-market funds, which pay an average 0.62% yearly, and into corporate, government and municipal bond funds, where the average return this year is 16.3%, according to research firm Morningstar Inc.
That's almost on par with the stock market's gains. But those gains will quickly turn into big losses if interest rates start rising briskly again.
Under ordinary circumstances, rising interest rates send bond prices moving in the opposite direction, hurting investors who depend on fixed-income holdings for some of their income. As investors rush out of lower-paying bonds into the higher-paying ones, prices overall fall. For every one-point rise in the federal funds and other interest rates, the price of a 10-year Treasury decreases by 8.5%; a rise of two percentage points would chop a 10-year Treasury bond's value by 17%, using figures from Barclays Capital.
The Federal Reserve has said it will keep rates low for "an extended period" to fight the recession, and most forecasters say any eventual rise will be slow and gradual. But some disagree. A Federal Reserve official, Kevin Warsh, rattled bond investors late last month by saying increases may come "with greater swiftness." The Fed controls only short-term rates, but pushing them up often affects longer-term rates—especially if inflation is in the air.
Investors can buy some cover by moving some or all of their cash into short-term bond funds, stable-value funds and bank certificates of deposits—three shorter-term investments whose values are less sensitive to rate shock. No one expects these conservative approaches to yield dazzling double-digit returns, and if interest rates remain low, the need for them won't be as pressing. But they all do better than money-market funds. "What's important is to protect capital and get some measure of a return," says financial adviser Ralph Courage, head of Courage Partners LLC of Norfolk, Va. Here's how the alternatives work:
Short-term bond funds. These portfolios, with corporate and government bonds that have average maturities of just under three years, are less vulnerable to rate changes than those with longer maturities. Compare two funds from the same family—Vanguard Short-Term Investment Grade, whose average maturity is 2.6 years, and Vanguard Long-Term Investment Grade, with a 22-year average. As interest rates fell over the past decade, the long-term fund has outperformed the short-term, rising an average 7.3% annually versus 4.9%. But in the event of a two-percentage-point rise in interest rates, the value of the long-term fund would drop 22%, compared with 3.9% for the short-term, according to Morningstar figures.
In 1994, when rates climbed two percentage points in six months, the Vanguard short-term fund lost a mere 0.8%. Today, its large amount of corporate bonds—40% of assets, compared with just 6% in Treasurys—could soften losses. Why? An improving economy would stoke demand for corporates, and the yield gap between Treasurys and corporates, now 1.3 points, would likely narrow, and prices of corporate bonds would fall less on a relative basis than Treasurys.
You can buy individual short-term bonds yourself. Treasurys can be bought when issued directly from the government, at the Web site TreasuryDirect.gov. Corporate, municipal and most other bonds must be purchased from a broker, and you can expect to pay 1% to 2% of assets in fees and markups.
Stable-value funds. Offered within 401(k)s and other defined-contribution retirement plans, these products aim to shield investors from market downdrafts and deliver modest returns. Last year, when the Standard & Poor's 500-stock index plunged 37%, stable-value funds were up 4.6%. This year, with the S&P ahead 18.8%, the funds have advanced just 2.3%, according to Hueler Analytics, a market research firm.
Stability is a pretty enticing message for shell-shocked investors, after two ferocious bear markets in stocks within the past decade. Small wonder these funds made up 30% of defined-contribution assets in mid-2009, up from 20% in 2007. The funds invest in high-grade corporate bonds, Treasurys, cash and asset-backed securities, mainly on the short-term side—a mix somewhat more susceptible to rate increases than short-term bond funds. A two-point interest rate rise results in a price drop of 6% for the underlying assets of the average stable-value fund, according to Stable Value Investment Association figures.
Investors who cash out, though, get a full 100 cents on the dollar of the fund's book value, regardless of the asset drop. The difference is made up by an insurance contract, called a "wrapper." Instances of investors losing money in stable-value funds are rare. One came earlier this year, as Chrysler teetered on the edge of bankruptcy, and a horde of the auto maker's white-collar workers withdrew their money from its stable-value fund. That overwhelmed the fund's protections, and it was liquidated. Investors ended up with 89 cents on the dollar.
Not everyone is a fan of the stable-value concept. "These things are sold by fear," says Barrett Porter, an adviser at money manager Abacus Portfolios LLC of Pacific Palisades, Calif. "Downside protection but minimal upside? I never have liked them." Nevertheless, according to a study by David Babbel, of the University of Pennsylvania's Wharton School, and Miguel Herce of consultant Charles River Associates, stable-value funds averaged 6.3% annual returns over 20 years through 2008, better than the average of 4.1% for money markets over that period, and the 5.7% delivered by Barclays' index for intermediate corporate and government bonds.
Certificates of deposit. They don't pay much in interest, but they do beat most money-market funds. The average one-year CD now yields 0.82%, says Informa Research Services Inc. They are covered by the Federal Deposit Insurance Corp., up to $250,000 for each bank account.
No one wants to be locked in a CD with low rates and years to run. To earn more while getting into position to do even better when rates rise, find community and regional banks (all federally insured) that are offering higher rates on CDs to build deposits. "They're a great place to hide" while awaiting rate boosts, says William Spiropoulos, chief executive of CoreStates Capital Advisors LLC in Newtown, Pa. Find them on BankRate.com.
For example, New South Federal Savings Bank, of Birmingham, Ala., is offering 2.13% for a one-year CD. Build a "ladder," allocating equal sums to cover CDs maturing after six months and one, two and three years. When the six-month CD matures, the former one-year CD now has six months left, the two-year has 18 months left and so on. Move the money from the mature CD into the vacant three-year slot at the top of the ladder, and you'll benefit when rates rise.
Write to Larry Light at larry.light@wsj.com
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