Even a coward can make decent money now.
With many investors terrified of the stock market and afraid to touch anything but U.S. Treasuries, investment advisers are trying to steer clients into bonds that are paying higher interest, while still being light on risk: the safest municipal bonds and high-quality corporate bonds.
Jack Ablin, chief investment officer of Harris Private Bank in Chicago, has been using bonds as a substitute for some stocks he would normally hold in clients' portfolios. So clients who typically would have 50 percent of their money in stocks now have only about 40 percent in stocks.
"We're making them safer," Ablin said. Yet, he said, returns are attractive. "Now, you are being paid handsomely to take on incremental risk."
Municipal bonds are a glaring example. Typically, municipal bonds pay less interest than Treasury bonds. So only after investors reap tax advantages do municipal bonds make sense.
But conditions have changed. Investors can make more money on some of the safest municipal bonds than they do on Treasuries, even before any tax advantage.
Take a State of Washington general obligation bond maturing in 2021. On Tuesday, it was yielding 5.26 percent, while a U.S. Treasury maturing at roughly the same time yielded 4.46 percent.
Shorter-term bonds can be even more attractive. For example, aCalifornia unlimited tax general obligation bond that matures in 2012 is yielding 4.2 percent. A comparable Treasury is at 1.95 percent.
For investors in high tax brackets, the benefit of the municipal bond is significant. Investors don't have to pay federal income tax on municipal bonds, so if you mix the tax savings in with the yield of the California bond, an investor in the 28 percent tax bracket would have to find a Treasury yielding 5.83 percent to do as well as in the municipal bond. Someone in the 33 percent tax bracket would have to find a Treasury yielding 6.27 percent.
"Munis are giving excellent income," says Matt Fabian, managing director of Municipal Market Advisors. And investors can enjoy that without taking on the risks in high-yield municipal bonds.
The safest municipal bonds are "unlimited tax general obligation bonds," in which a state government promises to raise whatever taxes necessary to make sure it pays back investors. There is some nervousness about a potential recession, but these are only slightly more risky than relying on the federal government to back Treasuries.
"Revenue" bonds are not nearly as reliable. They depend on projects to provide revenue for bondholders.
In the current environment, Fabian considers revenues too uncertain, and suggests investors avoid such bonds. "We recommend against high yield," he said.
Likewise, Ablin is staying clear of high-yield corporate bonds, which have plunged as recession threats increase. High-yield corporate bonds are issued by companies already experiencing financial trouble, and defaults—firms failing to pay bond investors—are mounting.
In such a treacherous economic environment, even high-quality, A-rated corporate bonds can experience trouble, as investors learned this year with companies such as Lehman Brothers.
Still, given the nervousness in the market, investors don't have to take on a lot of risk to obtain good returns. Moody's notes the yield on investment-grade industrial company bonds is a record-breaking 4.78 percentage points over Treasuries.
The higher yields on relatively safe munis and corporate bonds are being driven largely by desperate sales by hedge funds and mutual funds. With losses on stocks, they are being forced to sell top-quality bonds to raise money fast to provide cash for people wanting to bail out.
"Investors are selling what they can sell, not necessarily what they want to sell," said bond investor Marilyn Cohen of Envision Capital Management.
gmarksjarvis@tribune.com
