I have invested in floating rate funds since 1990 and still think they are a good investment. There have been good economic cycles and bad and they have held up through all of them. Is every company rated BB or below going to go out of business? That would mean the private sector, who if rated would be below BB, would all dissapear. All the banks would go under and the second coming would happen. Things are not that bad. Also, a 48% drop in the s&p did not kill theses investments.My main concern in the economy is the comsumer personal real estate debt which is the real bubble waiting to explode.

I know how this is gonna fly, but here goes:

JUST BUY BONDS.

Keep it simple, don't predict rates, don't predict the market.

Make your client's portfolio an income generating machine that gives them more income than they can spend.

If rates go up, what do we do?

Good news, we buy more bonds.

If rates go down what do we do?

Good news, we buy more bonds.

We don't predict the markets, we just keep buying bonds. The income keeps flowing. The client always gets 100 percent of their principal at maturity, never any splaining to do. And the excess can be DCA"d into more income or the equity market.

It's really simple, clients get it, and it blows away any power point/efficient frontier/Sharpes ratio presentation the competition cares to give.

Plus, we never know when another 01-02 market is going to show up and wipe away all those inflation hedging gains along with a great deal of the client's principal. Funny thing about all those slick PP pressos, none show losing 40% plus on the equity side in years one and two. Yet for those unfortunate enough to have jumped in during 01, that's their reality. What's the plan then? How exactly does one recover from losing 40% or more on 60% of a portfolio?

As for funds for the fixed side, I'm not a big believer. That said, I do use some, mostly for high yield. Funds, even the cheap ones, take too big a chunk of the return to manage an asset that essentially doesn't need to be managed. Putting say $100k into a bond fund with say a .5% expense ratio for ten years will cost the client in the neighborhood of $5000 in fees. Had that same client bought a ten year bond with a point and a half in it their cost is only $1500. Will the fund return enough to pay for the extra cost? Unknowable. Is the client taking more risk? Absolutely! So there are cost/risk factors. Then there's the questionable management. Most investors would have been better off without managers in the 94 and 98/99 bond market slides. These two periods are the benchmark tests for managers in modern times. How did they do? Not good! Loses were massive. Managers moved quickly to save their own skins by adjusting porfolios to the new market environment. Read that to say they locked in their fund's losses. In many cases never to be recovered. A wrong guess followed by another wrong guess. Their share holders paid the price with their net worth. Yet, clients who owned bonds, not funds, and who didn't panic, didn't lose a dime.

Good point, in a fund like Fidelity Advisor Floating Rate High Income, there has been little NAV fluctuation since 2000, for example. I see a parallel in your arguement to high yield muni bond funds like Oppenheimer Rochester National muni, the world would have to fall apart, and munis are still backed by the taxing power of local governments.

Seems like a fund, with full time professional management, should be able to steer clear of some potholes that could arise in individual security portfolio management. But with the current point in the economic cycle, is now the time to buy? Maybe hold these nexts to a TIPS fund, and total return bond, for some clients. The non correlation to stocks and bonds of TIPS is a very solid idea, too.

And of course, bond guy, if you can competently manage a portfolio of individual bonds, more power to you. For we wee generalists, or predictable returns on larger portfolios for that matter, I think by the time you bring in the more attractive high yield munis, developed country high quality, developing country, TIPs, etc. in addition to the traditional core bonds- these funds provide effective active management, at effective cost. In my estimation, the cost is justfied. But if you want to put it together yourself and do a good job, with less complexity, your fees are justifed.

I have invested in floating rate funds since 1990 and still think they are a good investment. There have been good economic cycles and bad and they have held up through all of them. Is every company rated BB or below going to go out of business?

Historically, about 1.5-2.5% of BB rated debt defaults each year.

[QUOTE] That would mean the private sector, who if rated would be below BB, would all dissapear. All the banks would go under and the second coming would happen.[/quote]

First of all, private companies can get credit ratings and bank loans, but they pay alot more for privilege. For example if my company wanted to get a loan, we would pay prime+2, or about 10% APR.

[quote]Things are not that bad. Also, a 48% drop in the s&p did not kill theses investments.[/quote]

Given that stock performance and credit performance are only weakly related, thats not at all surprising. Mr Market sets stock prices, reality sets credit prices and outcomes.

I saw the guy from Rochester (Mike Rosen). The ink on the Oppenheimer check was still wet when he was talking.

Here was a guy who just made millions in three funds, Long term Munis, Limited term Munis and Bond Fund For Growth. What was it he said?

"If you buy a long term Muni Fund and leave your money in it, You Are A MORON!"

The ink was wet but the check was cashed!

He pitched the Bond Fund For Growth, a convertible fund, I bought Mainstay instead. They had identical track records, but I knew the manager of BFFG had other things on his mind than running the fund.

Mr. A

[quote=BondGuy]Managers moved quickly to save their own skins by adjusting porfolios to the new market environment. Read that to say they locked in their fund's losses. In many cases never to be recovered. A wrong guess followed by another wrong guess. Their share holders paid the price with their net worth. Yet, clients who owned bonds, not funds, and who didn't panic, didn't lose a dime.[/quote]

I dunno, I think you need a huge amount of assets to create a diversified bond portfolio. I'm not going to spend the time doing credit analysis on bunch of bonds, when for 20bp you can own AGG, and get the entire investable bond universe. For clients who are more risk senstive, I use MBDFX (aka PIMCO Total Return)

In few months, the full set of Lehman government/credit indexes will be out as ETF's, and at that point bond funds are going to be mostly obsolete.

The only places I'd pay for bond management are for specialites like high yeild, and global.

BTW, in my experience clients do complain about "losing money" in bonds, even if you have to explain that they will get it all back.

I see a parallel in your arguement to high yield muni bond funds like Oppenheimer Rochester National muni, the world would have to fall apart, and munis are still backed by the taxing power of local governments.

High yeild muni's are their own sector, people have figured out that the HYmuni's are far far less risky than equivalent corp/ABS/synthetic debt.

*However* There is just so little default history that we don't know the risk of the current set of HY muni's. This is the same situation as in the early 1980s, where the only data on junk bonds came from "fallen angels" vs new issue junk.

Alot of states don't have as much taxing power as you would think, because of things like prop 13, etc. Taxing power is only worth something if you can tax and there is something to tax. The vast majority of HY-muni's are not GO's backed by taxing power, but instead revenue bonds, securitisations of cash flow streams, or secured by a lien on state funding.

Again, the basic rule is that if you lose clients money, you will lose clients.

[quote]Seems like a fund, with full time professional management, should be able to steer clear of some potholes that could arise in individual security portfolio management.[/quote]

But you pay alot for it.

[quote]But with the current point in the economic cycle, is now the time to buy?[/quote]

No, the yield curve sucks, 1 year T-Bills are the place to be.

[quote]Maybe hold these nexts to a TIPS fund, and total return bond, for some clients. The non correlation to stocks and bonds of TIPS is a very solid idea, too.[/quote]

But TIPS are bouncy as well, since they are deathly sensitive to changes in real interest rates. When real rates went from 75bp to 250bp, low yield TIPS got hosed.

"TIPS real duration are longer than nominal bonds because their real yields are low. However, their effective nominal duration is much shorter because they are not as sensitive to changes in expected inflation."

This confuses the heck out people, TIPS are barely affected by that part of the nominal interest rate that relates to inflation and expected inflation. They are very sensitive to real interest rates because of the very low real yeild.

This is a good intro to TIPS.

http://www.aicpa.org/PUBS/jofa/jan2007/boes.htm

[quote=AllREIT][quote=planrcoach]I see a parallel in your arguement to high yield muni bond funds like Oppenheimer Rochester National muni, the world would have to fall apart, and munis are still backed by the taxing power of local governments.[/quote]

Yup. That's tough to beat.

High yeild muni's are their own sector, people have figured out that the HYmuni's are far far less risky than equivalent corp/ABS/synthetic debt.

Yup again. Even though they may carry the same ratings, there is a world of difference between corp and munis.

*However* There is just so little default history that we don't know the risk of the current set of HY muni's. This is the same situation as in the early 1980s, where the only data on junk bonds came from "fallen angels" vs new issue junk.

There was a sea change within the corp junk market. Milken started an entirely new catagory of junk bonds. These bonds eventually collapsed the market. Milken was the fall guy. I don't see a similar pattern of runaway greed in the muni markets. There are some soft spots, like tobacco bonds, but if you know what you're doing you can steer clear of the absolute crap like hospital bonds etc. and you can be selective on tobacco.

Alot of states don't have as much taxing power as you would think, because of things like prop 13, etc. Taxing power is only worth something if you can tax and there is something to tax. The vast majority of HY-muni's are not GO's backed by taxing power, but instead revenue bonds, securitisations of cash flow streams, or secured by a lien on state funding.

There are many strong rev bonds, NJTP comes to mind.

Again, the basic rule is that if you lose clients money, you will lose clients.

You can't lose if you don't sell. So, don't sell. The client's income stream is unaffected by int rate moves. We remind clients that the income stream is what they signed up for. Rate moves do not change that. If rates move up buy more bonds at the higher rates. If the client wants out of the bonds it's on them. Of course there is a win win with a bond swap into a higher coupon.

[quote]Seems like a fund, with full time professional management, should be able to steer clear of some potholes that could arise in individual security portfolio management.[/quote]

The only true test was 94 and 98/99. Chk out how well they did then. Some are OK, but many aren't. Problem is, funds are managed for total return. If the bottom falls out of the market,as it did during these times, many managers make short sighted moves to sure up the portfolio. Those moves get expensive by locking in losses. 

But you pay alot for it.

[quote]But with the current point in the economic cycle, is now the time to buy?[/quote]

Do you know something about the future of interest rates that the rest of us don't?

No, the yield curve sucks, 1 year T-Bills are the place to be.

Very predictive. Try this "Mrs. client i have no idea where interest rates are headed. Now, my firm pays people millions of dollars a year to tell us where rates are going but honestly I couldn't tell you. And to be honest with you, I don't think those million dollar guys know either. All I know is that rates go up and then they go down and the best time to buy is when you have money to invest."

[quote]Maybe hold these nexts to a TIPS fund, and total return bond, for some clients. The non correlation to stocks and bonds of TIPS is a very solid idea, too.[/quote]

But TIPS are bouncy as well, since they are deathly sensitive to changes in real interest rates. When real rates went from 75bp to 250bp, low yield TIPS got hosed.

"TIPS real duration are longer than nominal bonds because their real yields are low. However, their effective nominal duration is much shorter because they are not as sensitive to changes in expected inflation."

Volatility, duration, inflation sensitivity... doesn't all this get tiring to keep track of? Find a good bond with a decent rating and JUST buy it. You can play to your heart's content with the yield curve thus controlling the volatiliy, duration, and inflation sensitivity. How hard does this have to be?

This confuses the heck out people, TIPS are barely affected by that part of the nominal interest rate that relates to inflation and expected inflation. They are very sensitive to real interest rates because of the very low real yeild.

Confusing people is never good. Seriously, if it's complecated and loses money you're sunk as well with the client.

This is a good intro to TIPS.

http://www.aicpa.org/PUBS/jofa/jan2007/boes.htm

Wow, great discussion. I will be reviewing to absorb some of the insights, obviously gleaned over time and experience. I don't think fixed income is truly easy for anyone to do well, but I get the feeling we should be revisiting it now.

Obviously holding individual issues beats funds for turnover/not holding to maturity issues, even fund liquidation/NAV problems which go back to the early 90s, I reckon, to be fully appreciated. A perfect storm.

So those of us who use funds, anyway, for pragmatic purposes, need to choose wisely.

[quote=planrcoach]

Yep, good idea to think of junk as equity and not fixed. I guess you hold the preferreds as individual securities and not funds?

I’m noting the current Investment News reports analyst consensus of S&P + 7% this year. That should get everyone’s attention - that would be 7%, withstanding political risk, etc. - best case.

So your preferreds would seem a risk-wise idea. And your CPIage exposure, well, now that Christ is back in Christmas, economists would say the demand should just flow somewhere else, aren’t we all worried about consumers. I just can’t believe that inflation is dispensed so easily. Unless we get into something wierd, like stagflation, have not really run money through that type of enviroment in a significant way.

Everyone would agree, fixed income takes on ever more importance in such an environment as today’s? Consider doing your homework and portfolio adjustments now, while the going is good.