Everybody is wondering how the stock market can be so high while the U.S. economy is so low. But you don’t hear the same rumbling concerns about the bond market – even though something very similar to ultra-high P/Es is going on in the fixed income side of your portfolio.
Q2 2020 hedge fund letters, conferences and more
Recently, the Barclay’s AGG index, which is the most common index tracked by ETFs, was yielding roughly 1.07% with a duration of six years – meaning, in layperson’s language, that if interest rates were to rise 1%, the ETF investors would lose 6% in price terms. This is a horrible risk/return profile.
But what are your alternatives for the fixed income segment of client portfolios?
Recently, I moderated a discussion with three professionals who constantly monitor the bond market from very different angles. Part of the conversation took place in a webinar, part of the Insider’s Forum conference’s “Three for Free” summer series. The rest of it came in preparation and supplemental interviews.
How different were the perspectives? The conversation included Eddy Vataru, chief investment officer of the total return strategy and portfolio manager at Osterweis Capital Management in San Francisco. Vataru worked with the Treasury Department in 2008-9 on its TARP program, trying to help stabilize the mortgage market while working as a senior staffer at the Blackrock organization, so he has seen the stimulus efforts from the inside and closely follow the Fed’s ever-ballooning QE programs. Vataru’s sector rotation investment strategy involves constantly evaluating the spreads at every point in the yield curve among corporates, Treasury bonds and agencies (mortgage debt), to identify sweet spots as they arise while watching the big picture developments in the overall economy.
Vataru’s portfolio, in contrast to the Barclay’s AGG index, is currently yielding roughly 2% with a duration of about three years – 50-75 basis points higher than the index, with about half the duration.
Also part of the discussion: Venk Reddy, chief investment officer and portfolio manager at Zeo Capital Advisors in San Francisco. Reddy invests in short-term high-yield bonds, which primarily requires him to avoid credit risk – very much like stock analysis to determine which companies are positioned to pay their bondholders.
Reddy’s portfolio is currently yielding just over 6%, with a 1.5 year duration.
Finally, the conversation included Jason Stuck, senior managing director and head of portfolio management at Northern Capital Securities Corporation in Boston. Stuck created a service at Northern Capital which helps advisory firms buy individual bonds (U.S. corporates and munis, predominately), either for individual clients or as sleeves in model portfolios. The service includes defining the goals of the portfolio, and modeling the performance of a proposed bond mix over the next 1, 2 and 3 years if interest rates were to rise 1%, 2% and 3%. The firm will then identify the best-priced individual bonds and buy them on behalf of the advisory firm at a disclosed 10 basis point fee. (If the bond yield is 3.10%, the yield to the client would be 3.00%.)
Northern Capital’s advisory firm clients tell Stuck that their clients want the fixed income segment of their portfolios to act like bonds, which means that if they hold the bonds to maturity, they know precisely the return they’ll be getting.
Article by Bob Veres, Advisor Perspectives
