Yield curve trap

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BondGuy's picture
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As we've already covered, the inverted yield curve shows us that the bond market is betting that rates are headed lower. Not only short rates, but long rates too. Could retirees be making a big mistake by not locking in today's long term rates?
I just read an article that brings this home. If short rates go from 5% to 3%, certainly withing the realm of possiblity, retirees relying on that income would take a 40% income cut. Hmm? That's a chunk of income. That's asset eating lifestyle changin income. So what to do?

troll's picture
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It suggests two simple things to me:1.  It is important for retirees to be careful about how they arrange their fixed income along the yield curve....to not fall into the trap of having everything short under the presumption that better days/higher rates lie ahead.2.  It is also advisable, IMHO, for even the most conservative investors to have some equity exposure.  This can come in the form of high quality dividend oriented securities, and provides a means of a.) hedging against uncertainty in future interest rates, and b.) perpetually growing one's capital base.

Indyone's picture
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You guys are making a pretty good argument for a VA with a 5-7% annual income benefit...

AirForce's picture
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VA's have been good...

troll's picture
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Indyone wrote:You guys are making a pretty good argument for a VA with a 5-7% annual income benefit...true dat homey!

skeedaddy2's picture
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I'd like to start by saying thanks for bringing up something other than
VAs, Ed Jones, Indy or Traditional and such.

I've never been a big proponent of bonds even though I've taken graduate
level coursework in the subject. I promise I won't go into the academic
discussion, so suffice it to say a low-tech, plain-vanilla way to proceed is
just a laddered portfolio. I've never had a client express any
dissatisfaction with this strategy. In fact, its been an excellent pre-cursor
to many rewarding client relationships.

Even though its not peeked much interest on this forum, we can't go
through a week without some Private Equity (PE) deal in the headlines. PE
is buying the cheap asset, which is stock, and selling the expensive asset,
which is debt. This IS the smart money, and that is HOW they are playing
it. We, as advisors should take note of this and convey this to our clients.

I would advise the following to an investor seeking income (as opposed to
an investor seeking only bonds): 20% utility stocks, 20% REITS, 20%
emerging market bonds, 20% high dividend stocks and 20% floating rate
bonds.

AllREIT's picture
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skeedaddy2 wrote:an investor seeking only bonds): 20% utility stocks, 20% REITS, 20%
emerging market bonds, 20% high dividend stocks and 20% floating rate
bonds.

Two points,

1) It's important to be very picky with REITs, alot of the valuations
of big REITs are just silly. REIT preferreds may be a much better value
all-in. IMHO people who buy ICF are going to get slaughterd when the
REIT correction takes place.

2) Floating rate securities is a tricky area since there are a lot of
crap senior loans entering the market. As Seth Klarman noted "The
banks' are senior but everyone is at risk". A senior position in the
capital stack does replace earning power. Some people in the debt
markets seem to forget that.

3) I'm going to say the same thing about EEM debt, I prefer investment
grade preferred stocks to junk debt of any source in the current
enviroment. In a little while the S&P preferred stock ETF will
start trading.

4) As much as TIPS are a chaotic source of income, I think a small allocation to TIPS is good in every portfolio.

5) An ETF like PFM, PID, VIG or SDY that is based on companies with an
history is increasing dividends is a great tool for income investors.
For my more income oriented clients I use a combination of PID/SDY.

skeedaddy2's picture
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AllREIT wrote:
skeedaddy2 wrote:an investor seeking only bonds): 20% utility stocks,
20% REITS, 20%
emerging market bonds, 20% high dividend stocks and 20% floating rate
bonds.

Two points,

1) It's important to be very picky with REITs, alot of the valuations
of big REITs are just silly. REIT preferreds may be a much better value
all-in. IMHO people who buy ICF are going to get slaughterd when the
REIT correction takes place.

You ought to be picky whenever you invest.

2) Floating rate securities is a tricky area since there are a lot of
crap senior loans entering the market. As Seth Klarman noted "The
banks' are senior but everyone is at risk". A senior position in the
capital stack does replace earning power. Some people in the debt
markets seem to forget that.

You can't overlook the fact that the historical default rate
in senior loans is less than 2%, odds that I'm willing to accept.

3) I'm going to say the same thing about EEM debt, I prefer investment
grade preferred stocks to junk debt of any source in the current
enviroment. In a little while the S&P preferred stock ETF will
start trading.

That's fine. Hey, different opinions are what makes a
market work. You're just missing out on the world's fastest growing
economies and very handsome rewards too.

4) As much as TIPS are a chaotic source of income, I think a small
allocation to TIPS is good in every portfolio.

You'll be taking the opposite side of Bill Gross. My money
is on him.

5) An ETF like PFM, PID, VIG or SDY that is based on companies with an
history is increasing dividends is a great tool for income investors.
For my more income oriented clients I use a combination of PID/SDY.

At least we agree on one point.

troll's picture
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skeedaddy2 wrote: You can't overlook the fact that the historical default rate
in senior loans is less than 2%, odds that I'm willing to accept.

Remember the old saying "Past performance is not necessarily indicative of future results."?Well I submit this is especially true in the state of the senior loan market.  Ten years ago it was a niche.  Nowadays the volume is huge and everyone on the street has a loan trading desk.  Individual investors are flocking to the funds, as they are desparate for yield, and their advisors are answering the call.  Many of these advisors buying the senior loan funds have never been through a high-yield meltdown, so they don't know better.It won't end well, IMHO.  HY spreads are the tightest they've been in years.  Now all we need is some sort of "oops" to shake people up!

AllREIT's picture
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joedabrkr wrote:
skeedaddy2 wrote: You can't overlook the fact that the historical default rate
in senior loans is less than 2%, odds that I'm willing to accept.
Remember the old saying "Past performance is not necessarily indicative of future results."?Well
I submit this is especially true in the state of the senior loan
market.  Ten years ago it was a niche.  Nowadays the volume
is huge and everyone on the street has a loan trading desk.

It's the same as Junk bond's pre 1982. Most junk bonds were "fallen
angels" trading at a deep discount to par vs fresh junk trading at par.
Totally different asset classes. And we all know how the 1980s junk boom ended.

Fitch ratings and other agencies are not amused at the low quality
loans that are comming to market. Covenant lite, and often the result
of dividend recap's and other non-productive uses of borrowed funds.

Something else that people are forgetting is how hard it is to raise money under normal conditions for company's who are already mortgaged-up with senior loans. Trying to flog CCC rated junior debt is no fun in a tight credit market.

Part of the reason senior default's are so low, is that it is so easy
to raise up junior debt at low rates in the current markets. So
obligors just roll over old loans as they come due.

Quote:Individual investors are flocking to the funds, as they are
desparate for yield, and their advisors are answering the call. 
Many of these advisors buying the senior loan funds have never been
through a high-yield meltdown, so they don't know better.It
won't end well, IMHO.  HY spreads are the tightest they've been in
years.  Now all we need is some sort of "oops" to shake people up!

And it's a double witching since spreads will go up as soon as default
losses start rising. So a portfolio of junk bonds will lose money on
the defaulted bonds, and the rest of the portfolio will decline in
price as well.

troll's picture
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It will be interesting to see how "liquid" or deep the market is when all those newby trading desks are trying to sell the same names into it....

aldo63's picture
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The highland  floating rate and ING (the old Pilgrim prime rate fund) have been through bad times before. I would rather take the risk of default on these investments than buy a 30 treas. paying 4.92% even if logic says that rates are going down. I will not buy a reit  common stock now, but I will the preferreds. But if rates go lower, the market should go higher. ii hope

troll's picture
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aldo63 wrote:The highland  floating rate and ING (the old Pilgrim prime rate fund) have been through bad times before. I would rather take the risk of default on these investments than buy a 30 treas. paying 4.92% even if logic says that rates are going down. I will not buy a reit  common stock now, but I will the preferreds. But if rates go lower, the market should go higher. ii hopeDefine "bad times"...

AllREIT's picture
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joedabrkr wrote: aldo63 wrote:The highland  floating rate and
ING (the old Pilgrim prime rate fund) have been through bad times
before. I would rather take the risk of default on these investments
than buy a 30 treas. paying 4.92% even if logic says that rates are
going down. I will not buy a reit  common stock now, but I will
the preferreds. But if rates go lower, the market should go higher. ii
hopeDefine "bad times"...

Hard times. Like when defaults happen, the IPO markets get tight and
credit spreads widen alot. Say 1989-1991. The market for junk loans
isn't all that big, so you have all these funds, invested in all the
same names.

And survival bias causes a real problem since the good credits pay off
their loans quickly, while the bad credits linger and die on you. Given
that defaults tend to start up around T+3, we are about a year or so
away from the first wave of "credit events"

Nows a great time to move up in credit quality.

troll's picture
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AllREIT wrote:joedabrkr wrote: aldo63 wrote:The highland  floating rate and
ING (the old Pilgrim prime rate fund) have been through bad times
before. I would rather take the risk of default on these investments
than buy a 30 treas. paying 4.92% even if logic says that rates are
going down. I will not buy a reit  common stock now, but I will
the preferreds. But if rates go lower, the market should go higher. ii
hopeDefine "bad times"...

Hard times. Like when defaults happen, the IPO markets get tight and
credit spreads widen alot. Say 1989-1991. The market for junk loans
isn't all that big, so you have all these funds, invested in all the
same names.

And survival bias causes a real problem since the good credits pay off
their loans quickly, while the bad credits linger and die on you. Given
that defaults tend to start up around T+3, we are about a year or so
away from the first wave of "credit events"

Nows a great time to move up in credit quality.
Not sure I know what you mean by t+3, but agree with your sentiments regarding quality.The difference between those "bad times" and now is that there is a LOT more players in the market, many with limited experience, and a lot of cash sloshing around seeking incremental returns.  Many of these bonds are bought on leverage aka 'the carry trade', and if things start to go south it could, IMHO, get ugly quickly.And then you have all the individual investors who purchased these as "CD alternatives", and how they will react when they see values decline on their statements.

AllREIT's picture
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Not sure I know what you mean by t+3, but agree with your sentiments regarding quality.

I ment that defaults start happening as loans get seasoned, usually they start up around year three.The
difference between those "bad times" and now is that there is a LOT
more players in the market, many with limited experience, and a lot of
cash sloshing around seeking incremental returns.  Many of these
bonds are bought on leverage aka 'the carry trade', and if things start
to go south it could, IMHO, get ugly quickly.
There is also a huge market for
credit default swaps and all sorts of other untested speculative
instruments. Alot more people are speculating on junk debt than
actually own it.
And then you have all the individual investors who purchased these
as "CD alternatives", and how they will react when they see values
decline on their statements.

Badly, They will react badly.

Alot of people who wouldn't think to have a portfolio that was 25% junk bonds think nothing of having 25% in junk loans.

planrcoach's picture
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Being a weaner generalist, I like to use some of the brand name strategic income bond funds, like Fidelity Advisor Strategic Income, and other "big" names.
It will be interesting to see how they handle the junk bond portion of the portfolios through active management, or balance that against the international and higher quality shorter duration.
Anyone else using this as part of their strategy - getting nerous, feeling good?
Joe, you are the CFP whiz student now, we are counting on you. Would that be Treasury plus 300 basis points, or something? I forgot a lot of that really important stuff. The Fidelity guys in Boston all wear neckties (even when they come out west) and they seem to be really smart. I throw in a few other geographic regions, neckties plus golf clothes, brand names, ETFs, TIPs, cash, advise client to buy a big home for potential appreciation and tax savings, and pray for the best. But I'm getting nervous again.
 

skeedaddy2's picture
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joedabrkr wrote:
skeedaddy2 wrote: You can't overlook the fact that the
historical default rate
in senior loans is less than 2%, odds that I'm willing to accept.

Remember the old saying "Past performance is not necessarily
indicative of future results."?Well I submit this is especially true in the
state of the senior loan market.  Ten years ago it was a niche.  Nowadays
the volume is huge and everyone on the street has a loan trading desk. 
Individual investors are flocking to the funds, as they are desparate for
yield, and their advisors are answering the call.  Many of these advisors
buying the senior loan funds have never been through a high-yield
meltdown, so they don't know better.It won't end well, IMHO.  HY spreads
are the tightest they've been in years.  Now all we need is some sort of
"oops" to shake people up!

I happen to like the fact that there are more participants in this market.
I'd much rather prefer a more transparent and liquid market to invest in.

Following your point about a melt-down in Sr. FRNs would suggest that
we should stay away from all other asset classes for fear of a melt-down
too, and we all know that's not practical (if we want to stay in this
business). None of these should be positioned as a CD alternative.

Looking at some historical performance (as measured by the CSFB
Leveraged Loan Index), the asset class did well during difficult bond
markets, 1994 & 1999, way better than high yield and govi's. Basically,
you're getting the same return as govi's with 1/3 the volatility.

The question was "what to do?" about a client seeking income and I
offered my two cents. Finding the right mix of returns and volatility for
your client is how we add value to a relationship.

troll's picture
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I don't use many "strategic income" products because frankly I'm not comfortable with not knowing what is under the hood.When I can get a 6% current yield and about a 5% expected YTM/ELTR on a plain vanilla "pays cash monthly" GNMA UIT from First Trust, I fail to see the attraction of taking the risk involved in some of these other products.  There is extension risk in the GNMA's, but no credit risk.  If I want to be even a little more conservative we can put some of the $ in 1-2 year CD's or corps.For funds I use DGCAX and VFSTX, and read the profiles carefully to make sure they are staying investment grade.I owned a bunch of PHD-a senior loan fund which is managed by Highland Capital.  Many guys believe them to be the best in the business.  I bought a little on the IPO at 20, and loaded up when the IPO ended up being "broken"(like many CEF IPO's) and bought a whole bunch around 16 and 17.  I just got done tossing all of it last month after reading a thread on here where several folks implied that they were using this asset class as a "CD alternative", and talking about how there was really not much risk.  That was enough for me.  I pulled up my cross post, found that I had gains of around 20% mostly in tax sheltered accounts, and punted all of it within a week or so.  That included some that I owned personally at a nice profit.I'll miss the 9% plus dividend, but in the end this is a specialized and leveraged junk bond fund in a market niche that has exploded in volume in the last 5-10 years.  I'll sleep just fine at night knowing I took my profits off the table.  When the defaults start up and the valuations drop because everyone wants out, then I'll come back.I feel much the same about REITS right now.planrcoach wrote:Being a weaner generalist, I like to use some of the brand name strategic income bond funds, like Fidelity Advisor Strategic Income, and other "big" names.
It will be interesting to see how they handle the junk bond portion of the portfolios through active management, or balance that against the international and higher quality shorter duration.
Anyone else using this as part of their strategy - getting nerous, feeling good?
Joe, you are the CFP whiz student now, we are counting on you. Would that be Treasury plus 300 basis points, or something? I forgot a lot of that really important stuff. The Fidelity guys in Boston all wear neckties (even when they come out west) and they seem to be really smart. I throw in a few other geographic regions, neckties plus golf clothes, brand names, ETFs, TIPs, cash, advise client to buy a big home for potential appreciation and tax savings, and pray for the best. But I'm getting nervous again.
 

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i am more concerned about the residential real estate market than floating rate funds. I do not use the leveraged floating rate products. The senior bank loan market is more liquid than the longer term high yield market and certainly more than real estate which I believe the defaults are coming. There is much more money  in loans to higher credit risk customers, small business,developers,ect than senior floating rate funds. There is a market for floating rate loans,where real bank loans to a small busines have no liquidity. If you put a credit rating on most small business it would be in the junk range. Many banks will fail if this scenerio happens. So what you are saying is that we are going to have a 1929 type collapse? If that is the case, i believe in the put you money in a shoebox theory.
We also had this discussion on this board early last year and NOTHING HAPPEND except a 7.5% return on the highland floating rate fund.

troll's picture
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aldo63 wrote:i am more concerned about the residential real estate market than floating rate funds. I do not use the leveraged floating rate products. The senior bank loan market is more liquid than the longer term high yield market and certainly more than real estate which I believe the defaults are coming. There is much more money  in loans to higher credit risk customers, small business,developers,ect than senior floating rate funds. There is a market for floating rate loans,where real bank loans to a small busines have no liquidity. If you put a credit rating on most small business it would be in the junk range. Many banks will fail if this scenerio happens. So what you are saying is that we are going to have a 1929 type collapse? If that is the case, i believe in the put you money in a shoebox theory.
We also had this discussion on this board early last year and NOTHING HAPPEND except a 7.5% return on the highland floating rate fund.Actually we had the conversation early in the 4th quarter, and that's when I decided to make the move...

AllREIT's picture
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joedabrkr wrote: I don't use many "strategic income" products because
frankly I'm not comfortable with not knowing what is under the
hood.
See, I have no problem with junk debt. I have a big problem when it
gets called something other than junk. I.e "strategic income" or
"floating rate" etc.
Quote:When I can get a 6% current yield and about a 5% expected
YTM/ELTR on a plain vanilla "pays cash monthly" GNMA UIT from First
Trust, I fail to see the attraction of taking the risk involved in some
of these other products.  There is extension risk in the GNMA's,
but no credit risk.  If I want to be even a little more
conservative we can put some of the $ in 1-2 year CD's or corps.

Joe, aren't you an RIA/IAR? If so what are you doing with UIT's?
Quote:For funds I use DGCAX and VFSTX, and read the profiles carefully to make sure they are staying investment grade.
In a little while VG is going to roll out Fixed income ETF's. I'm 
very interested in the VG Lehmann AGG etf, based off the total bond
market fund.

Right now there are three short ETF's from BGI

SHV == 1Y- TSY
CSJ == 1-3 Corp
SHY == 1-3 TSY

For people who need a big TSY money market position SHV is perfect. Only 20bp. These days I'm pretty SHY.

Quote:I owned a bunch of PHD-a senior loan fund which is managed by
Highland Capital.  Many guys believe them to be the best in the
business.

Another group that is good is NYLIM/Mainstay. In their last
presentation they talked about having default rate 1/2 of the CFSB
index. NYLIM manages some huge fixed income portfolio's so they have
experience.

As for me. My clients get junk/leveraged exposure via commercial
mortgage REITs like NCT/KFN etc. It is my opinion that commercial
mortgages are safer than junk debt because of the overcollateralised
hard assets underneath them. Of course I bought NCT/KFN when they were
trading at 23 or so.

I happen to think that Fortress/KKR are better junk debt managers than
anyone who operates retail-oriented investments. Also the inside
management owns a ton of shares, so they are "motivated".
Quote:When the defaults start up and the valuations drop because everyone wants out, then I'll come back.I feel much the same about REITS right now.

REITs is tricky because the REITs that are in the indexes, are
horrifically overvalued. But outside the indexes, lots of REITs are
attractivly priced.

troll's picture
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Allreit I am dually registered IAR and Reg Rep.I find that some folks, particularly older clients, prefer not to pay fees.

aldo63's picture
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Joe
I guess we will revisit this later in the year.
by the way, I sat in on a conference call with the manager of the Ager China fund. Of course he was positive but when I ask about liquidity, currency, accounting, and how mutual fund inflows are pushing up the prices ect, I decided this was an area to get out of...ASAP. I still believe the dollar will still decline this year and international should do well, but i am getting out of Emerging markets. Since this is a fixed income board, what about international bond funds? get out or stay in?? 
 

troll's picture
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aldo63 wrote:Joe
I guess we will revisit this later in the year.
by the way, I sat in on a conference call with the manager of the Ager China fund. Of course he was positive but when I ask about liquidity, currency, accounting, and how mutual fund inflows are pushing up the prices ect, I decided this was an area to get out of...ASAP. I still believe the dollar will still decline this year and international should do well, but i am getting out of Emerging markets. Since this is a fixed income board, what about international bond funds? get out or stay in?? 
 I am out of international bonds right now due to expected strength in the dollar.....

blarmston's picture
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JoeDaMan,
You think the dollar will strengthen? What are your thoughts on that...

troll's picture
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blarmston wrote:JoeDaMan,
You think the dollar will strengthen? What are your thoughts on that...Yes I do.

AllREIT's picture
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joedabrkr wrote:
I am out of international bonds right now due to expected strength in the dollar.....

I disagree with that, mostly because alot of dollar strength comes from
the fact that it is a high(er) yeilding G7 currency. I think currency
markets are a complete mystery though...

What is notable is how much FOREX affects international investments. PID had a huge run up b/c of this. The currency hedged EEM/EFA indexes did not do so well as the USD index.

PIMCO runs a nice ex-US bond fund, which makes a good complement to otherinternational investments.

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aldo63 wrote:by the way, I sat in on a conference call with the manager of the Ager China fund.

Evergreen is running a conference call today with GMO's Jeremy Grantham. Should be very interesting.

troll's picture
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AllREIT wrote:

I disagree with that, mostly because alot of dollar strength comes from
the fact that it is a high(er) yeilding G7 currency.
That, my friend, is what makes a market!FYI I "think" the Pimco fund you mention uses hedging.  Makes currency fluctuations less relevant if they do it right.

BondGuy's picture
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Interesting discussion so far. Here's a question: Many of the replies advocate staying short. Many of the replies advocate the use of funds. How does staying short, and how will funds protect income of today's INCOME investor. Again, we could care less about total return. We only care about delivering income.

Indyone's picture
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I'm staying short.  Hindsight tells us that staying short in the early 80's was a mistake, but today's baseline number is far different than 18-20%.  Will taking 5% in the 1-3 year range hurt my clients?  Only time will tell, but it's a risk that I and my clients have accepted at this point.
For income, I'm using a variety of income plays apart from bonds, including the latest...covered call ETFs yielding north of 8%.  VA's with income and principal guarantees are yet another tool that works for some of the population.  There's no magic bullet and not any one strategy works universally, but if you're looking for income, it's probably prudent to include other vehicles in addition to bonds, even if you are a "Bondguy"...
...and BG, I'm not implying that your universe is limited to bonds...just a little tounge-in-cheek...

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Many of the replies advocate the use of funds. How does staying short, and how will funds protect income of today's INCOME investor. Again, we could care less about total return. We only care about delivering income.
I think there are a lot of ways you can protect income. Doing your own research is great - higher net worth clients increasing expect their advisors to show new ideas and fancy strategeis.
The comment about pulling back from international bonds, due to a strengthening dollar is interesting. I'd rather delegate this decision, as well as the timing of duration, quality etc. - to the managers of various multi category strategic bond funds. Still have the usual cash, laddered cds, stock market certificates, and TIP funds, etc.
Bond funds can get hammered during the economic cycle, but I think flexible allocation goals in the multipurpose bond funds will help with that risk, compared with some of the products we had in the early 90s.
Since inflation is a risk, stock dividends, convertibles, preferrreds etc, are still very important. But I delegate in funds
And no matter how you cut it, guaranteed income products will be extremely important to the retiring boomers so they can't outlive their income. No individual security will fill the bill - we already had that discussion.  
Not very sophisticated on my part, but it seems to work okay.

BondGuy's picture
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Indyone wrote:
I'm staying short.  Hindsight tells us that staying short in the early 80's was a mistake, but today's baseline number is far different than 18-20%.  Will taking 5% in the 1-3 year range hurt my clients?  Only time will tell, but it's a risk that I and my clients have accepted at this point.
For income, I'm using a variety of income plays apart from bonds, including the latest...covered call ETFs yielding north of 8%.  VA's with income and principal guarantees are yet another tool that works for some of the population.  There's no magic bullet and not any one strategy works universally, but if you're looking for income, it's probably prudent to include other vehicles in addition to bonds, even if you are a "Bondguy"...
...and BG, I'm not implying that your universe is limited to bonds...just a little tounge-in-cheek...

No prob with a little tonuge in cheek jabbing. The purpose of this thread is to get everyone thinking about how best to protect income. Technically, there are no wrong answers.
 My questioning of staying short goes to the  issue of betting client's future income on an interest rate prediction. 5% plus is OK today, but it get's ugly down the road if the yield curve proves to be an accurate predictor of rates going lower. Thus the yield curve trap.
My questioning of the use of funds goes to the fact that funds offer absolutely no income protection in a down rate scenerio. Shareholders counting on income come up short, while fund managers thump their chests over their spectacular total returns.
I like many of the solutions I've read. The use of preferreds,and div paying stocks gets an A+ in my book. Covered calls and covered call funds also, a good idea. Buying some long term paper of choice today, also in my book a good way to go.
I have one client who will only buy the longest investment grade paper out there, tax free. Her attitude is "Just buy bonds" when she has the money to do so. She doesn't care about interest rate predictions. She's told me many times. nobody knows, so why worry about it. Just show her the highest yield paper within her default risk parameters. She's in her eighties and sharp as a tack. She has a lot of money split between me and a wirehouse broker. With me, she's all tax free.
Think about this for a moment. This woman does nothing fancy. She just buys bonds. Her account today yields well over 5%, maybe as high as 6% tax free. A few years ago it was still over 8%. She has never lost a cent of income to the porfolio insurance strategies of laddering, bar bell, or similar play it safe techniques. She wants income and she's maxed it out. Sometimes keeping it simple is something to consider. How many thousands of dollars have we, as the smartest minds on the planet, talked clients out of by complicating the matter with our strategies? Strategies based on predictions? Strategies that take the predictions off the table? With this client that answer would be zero.
 

planrcoach's picture
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  How many thousands of dollars have we, as the smartest minds on the planet, talked clients out of by complicating the matter with our strategies? Strategies based on predictions?
Strategies based on trying to outthink the market, add value to a brutally competitive 24/7 global market place.
"Just buy bonds" is the fixed equivalent of Buffet's, "just own companies on the up verticle supply side of basic industries".
Keep it simple and sustainable.
My speciality is the mass affluent market. I feel sorry for advisors catering the affluent, who are not either continually specializing, or who are continually splitting the basic portfolio managment functions into fine hairs - trying to time segments, focus on costs, focus on performance. The strategic value added at low cost could be costly. That can only 'end badly for everyone'.

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Certainly staying short has it's risks, and I'm not here to call the bond curve prediction wrong, but the curve notwithstanding, I have a pretty strong feeling that the risk/reward is in favor in keeping clients short.  Hopefully, this thread will be preserved and we can revisit the issue at the beginning of the next three years and see where things actually ended up.  Those are some of the best lessons we can get...the benefit of 20/20 hindsight...

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BondGuy wrote:Again, we could care less about total return. We only care about delivering income.

That's silly. Give me $1000 and I'll guarantee I'll get you a 10% return for 10 years.

I can also do a 20% return for 5 years if you would prefer that.

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"I have one client who will only buy the longest investment grade paper out there, tax free. Her attitude is "Just buy bonds" when she has the money to do so. She doesn't care about interest rate predictions. She's told me many times. nobody knows, so why worry about it. Just show her the highest yield paper within her default risk parameters." Bondguy
Net result? She has a defacto bond ladder. Maybe it's not exactly smooth, but she probably always has bonds maturing, being called, being Pre Re'd tons of interest each month. It's a wonderful thing! Short term rates? What does she care? Her six month paper is yielding 5.35% (at least that's what she told me!)
Mr. A

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joedabrkr wrote:
AllREIT wrote:

I disagree with that, mostly because alot of dollar strength comes from
the fact that it is a high(er) yeilding G7 currency.
That, my friend, is what makes a market!FYI I "think" the Pimco fund you mention uses hedging.  Makes currency fluctuations less relevant if they do it right.

PIMCO offers unhedged and hedged xUS funds.The hedged funds don't yield very much. I use the unhedged fund to complement allocations to xUS stocks.

More seriously, we all know about ladder'd bond portfolio's and so bond
funds are great way to reduce default risk and keep a target duration.

The marginal return from owning longer paper over shorter paper does not offset the added portfolio volatility.

This is the best article on bonds ever written:

http://www.pimco.com/LeftNav/Viewpoints/2006/Role+of+Bonds +6-2006.htm

Basicly I classify a portfolio like so

Stable Cashflow (Bonds)
Variable Cashflow (MM + Loans)
Growing Cashflow (Dividend stocks + TIPS)
No Cashflow (Microcap stocks + Other risk assets)

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joedabrkr wrote: aldo63 wrote:
i am more concerned about the residential real estate market than floating rate funds. I do not use the leveraged floating rate products. The senior bank loan market is more liquid than the longer term high yield market and certainly more than real estate which I believe the defaults are coming. There is much more money  in loans to higher credit risk customers, small business,developers,ect than senior floating rate funds. There is a market for floating rate loans,where real bank loans to a small busines have no liquidity. If you put a credit rating on most small business it would be in the junk range. Many banks will fail if this scenerio happens. So what you are saying is that we are going to have a 1929 type collapse? If that is the case, i believe in the put you money in a shoebox theory.
We also had this discussion on this board early last year and NOTHING HAPPEND except a 7.5% return on the highland floating rate fund.
Actually we had the conversation early in the 4th quarter, and that's when I decided to make the move...
I second that.  I told my clients "We are probably 6 -12 months early moving out of floating rate, I'd rather be 6 months early than a day late"  There is so much CD money that is in floating rate because it was sold solely on the yield.  When NAVs start to decline, and people head for the exits (and have to wait up to 90 days) at the same time, it will barely matter which fund company you are with.  My clients appreciate that they were in floating rate for the "easy money"  moved it all to  agencies and munis.

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AllREIT wrote: BondGuy wrote:Again, we could care less about total return. We only care about delivering income.That's silly. Give me $1000 and I'll guarantee I'll get you a 10% return for 10 years.I can also do a 20% return for 5 years if you would prefer that.
Clearly, you don't get it.

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mranonymous2u wrote:
"I have one client who will only buy the longest investment grade paper out there, tax free. Her attitude is "Just buy bonds" when she has the money to do so. She doesn't care about interest rate predictions. She's told me many times. nobody knows, so why worry about it. Just show her the highest yield paper within her default risk parameters." Bondguy
Net result? She has a defacto bond ladder. Maybe it's not exactly smooth, but she probably always has bonds maturing, being called, being Pre Re'd tons of interest each month. It's a wonderful thing! Short term rates? What does she care? Her six month paper is yielding 5.35% (at least that's what she told me!)
Mr. A

Defacto ladder, with the emphasis being defacto. She has no way of knowing rates would drop, nor does she care.

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Allreit strikes me as the guy who goes 76 in the fast lane on the interstate. "That's fast enough and if I slow people down, then they're finally doing it right."
Don't waste your time.
Mr. A

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Indyone wrote:Certainly staying short has it's risks, and I'm not here to call the bond curve prediction wrong, but the curve notwithstanding, I have a pretty strong feeling that the risk/reward is in favor in keeping clients short.  Hopefully, this thread will be preserved and we can revisit the issue at the beginning of the next three years and see where things actually ended up.  Those are some of the best lessons we can get...the benefit of 20/20 hindsight...
Indy, you know I have great respect for you. I wasn't asking you to defend your position. you may be right, however there is no right or wrong here, just opinions.
To all: Telling you about my client who does nothing but worry free buying of LT bonds whenever she has cash to invest wasn't to give you a strategy to challenge. It was to show that even the simplist of strategies can work. This woman has, over the 20 years we've been doing business, outperformed the best of the best on wall street. And she's done so without trying. She simply wants to maximize her income. The lesson is don't over think this.

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BondGuy wrote:
 
Indy, you know I have great respect for you. I wasn't asking you to defend your position. you may be right, however there is no right or wrong here, just opinions.
To all: Telling you about my client who does nothing but worry free buying of LT bonds whenever she has cash to invest wasn't to give you a strategy to challenge. It was to show that even the simplist of strategies can work. This woman has, over the 20 years we've been doing business, outperformed the best of the best on wall street. And she's done so without trying. She simply wants to maximize her income. The lesson is don't over think this.
Oh, and one other lesson. Don't think you know more than little old ladies. Chances are you don't.

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Actually, that thought crossed my mind as well when I read your post.

I don't separate the price of the asset from it's yield..unless you're talking
about holding bonds to maturity exclusively. It's not common, but it does
happen. I too had a client, who at 90 years of age, bought 20+ year bonds,
seeking only the highest available yield with no regard for asset price
volatility.

As far as "over thinking", it was YOU who asked for our opinions on the
subject. I hope you enjoyed it, you sadist.

mranonymous2u's picture
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Bondguy,
What I find fun about bond buying is finding the best deal, most times it's cashflow. Once in a while it's total return, like the Zeroes (but that's usually equity money, not bond dough) or premium bonds or low quality, high coupon Munis looking at a Pre Re (those are fun I love it when I'm right on those. Pre Re's seem to be more frequent in a rising rate scenario, so you have a winner in a losing bond market! Sweet!) Likewise, premiumed preferreds have a tendency to rise as the probability of their being called goes away too.
Not to hawk a name but the FredMac five year floater (fre.l) has done a good job for me and can continue to do so (if rates don't tank too much) as I recall, it reset in 05 and will reset again in 10 based on the 5yr Treasury (4.747 today). That implies a dividend of $2.36 which is 5.55% at this price and $56 based on today's yield. But let's say the preferred goes back to par for the reset. So I get $1.79/year income (4.215%) plus the growth from 42.5 to 50 ($7.5) in three years 5.88% per year. OK, it's not likely to get all the way to $50 if it goes to $45.5 I added 235 beeps, 6.5% not bad for government work. (BTW, I think there is much too much inflation in the world for rates to drop too much. Otherwise known as, at all.)
Mr. A

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Indy,
"....the benefit of 20/20 hindsight..."
It is my experience that, "Hindsight is 50/50 at best!"
That's mine, but you can use it!
Mr. A
 

Indyone's picture
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BG, I didn't post that last bit on the defensive (at least not consciously, anyway), and I'll say without hesitation that my knowledge of the bond world is nothing to brag about and certainly not in the realm of a veteran specialist such as yourself.  Likewise, I don't have any premonition about being right 1, 2, or 3 years out...I just like looking back later at predictions and seeing what view ended up being the right one and why...that is usually some very good information.  That's what I meant about 20/20 hindsight lessons.
Based on where rates stand today, I like my chances or I wouldn't skew my clients that way, although like many who lack the courage of strong convictions, I've outsourced most of the bond management to fund managers.
BTW, where did all the fat (8-9%+) yields go on 1-3 year US auto paper go?!!  I had a good thing there...even finding YTMs of up to 13% on Ford paper of less than three years last summer...man, is that stuff gone!

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BondGuy wrote:Defacto ladder, with the emphasis being defacto. She has no way of knowing rates would drop, nor does she care.

Most clients would be annoyed at all the fluctuation from having a high
duration portfolio. If 15bp pays for your zantac, so be it.

I still like my 20% for 5 years plan. High income and no risk, total return is pretty weak though.

mranonymous2u's picture
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Reit,
It wasn't funny the second time someone told the "Double your money, fold it in half and put it your pocket" joke either.
I generally find that when people feel the need to put a laugh track on their own jokes, it's because the joke isn't funny, and the author is pretty dull.
Mr. A

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