By Brenda Wenning/local columnist
The MetroWest Daily News
Posted Aug 15, 2010 @ 12:04 AM
Mention investments and the first thing most investors think of is stocks. Bonds are the poor stepchild, often ignored or overlooked.
They may not offer the sometimes spectacular results that stocks provide, but they are also unlikely to cause the huge drops in value that stock investors have endured. They can be a steadier contributor to your investment portfolio. Ideally, they are not a substitute for stocks, but a complementary investment, providing diversity and stability, in addition to income and long-term returns.
With interest rates at historic lows and the possibility that they may rise soon, it may seem like an odd time to think about investing in bonds. After all, when interest rates rise, bonds drop in value. But even in today’s economy, bonds can provide opportunities, especially for risk-averse investors.
The many faces of bonds
Many investors lack an understanding of bonds, which typically are issued to finance capital projects, either by government agencies or by corporations. Bonds are "fixed-income" securities. Their value fluctuates, but they also pay income on a regular basis and the income rate stays the same until the bond matures.
Government bonds include municipal bonds, or "munis," which finance local projects, and three types of bonds issued by the federal government - long-term Treasury bonds, short-term Treasury bills and medium-term Treasury notes.
Government bonds do not offer high returns, but they are low-risk investments and provide tax advantages, such as exemption from state and municipal taxes.
Corporate bonds can provide higher returns, but they are riskier and do not provide tax advantages.
Mortgage-backed securities (MBS) are another type of bond, but one that proved to be far riskier than anticipated, becoming the central cause of the financial crisis of the past few years.
To determine how risky a bond is, investors can check its rating, although keep in mind that the rating agencies typically gave MBS very high ratings before they defaulted.
A bond with a B rating or lower is typically referred to as a "junk" bond. It may pay a higher "yield" than bonds with a higher rating, but it also carries a higher risk of defaulting.
Bond investment strategies
So how should bonds figure into your investment strategy?
Here are a few examples:
Alternative to "cash equivalents." Spooked by volatility, many investors have parked their savings in money market funds and certificates of deposit, even though the interest rates these cash equivalents are paying are at record lows.
Short-duration, high-quality bonds and bond funds are a better alternative for risk-averse investors. They can provide a yield that beats CDs and money market funds and they carry little risk.
Source of income. Investors who are willing to accept greater volatility in return for more income should consider investing in "spread sector" bonds. Spread sector bonds include all bonds that provide higher yields than Treasuries; the difference is referred to as a "spread." While spread sector bonds carry more risk than Treasuries, their higher yields provide a hedge against downside risk.
In addition, with the exception of MBS, spread sector bonds are less sensitive to changes in interest rates than Treasuries.
Corporate bonds, MBS and government agency bonds typically outperform Treasuries as the economy improves. Economic growth increases revenues and improves credit quality. Think the financial crisis is fading and the economy is improving? If so, spread sector bonds may be appropriate for you.
Diversification. As part of an asset allocation strategy, bonds can reduce overall risk and volatility, which should lead to higher long-term returns. As with stocks, diversification can reduce risk and increase returns long-term. When one type of investment performs poorly, another type of investment is likely to perform well, which will help to offset losses and potentially provide a higher long-term return.
For example, balancing investment-grade bonds with less creditworthy, but higher yielding bonds may provide higher returns over time. Likewise, consider balancing corporate bonds and government bonds, including U.S. Treasury and municipal bonds.
Laddering and barbells
In addition to diversifying among different types of bonds, investors should consider diversifying among bonds with different maturities.
One way to diversify maturities is to use a technique called "laddering," which can reduce your portfolio’s exposure to interest-rate risk. To build a laddered portfolio, you purchase bonds that mature throughout a set investment period. For example, if your investment period is 10 years, you may buy five bonds with maturity periods of two, four, six, eight and 10 years.
When the first bond matures, you replace it with a 10-year bond, maintaining your ladder by adding another rung at the end of your ladder. By laddering your portfolio, you are spreading your risk over not only different time periods, but different interest rates.
Bonds with short-term maturities have a high degree of stability but provide a lower yield than long-term bonds. Long-term bonds provide higher yields, but are very sensitive to changing interest rates. By laddering your portfolio, you will earn a higher return than if you were only invested in short-term bonds, but have less risk than if you were only invested in long-term bonds.
You will also have greater liquidity than if you were investing only in long-term bonds, as at least one bond in your portfolio will mature every year or two, depending on how you build your ladder.
Keep in mind that this is a long-term strategy and does not take the current interest-rate environment into account.
Although not recommended during the current interest-rate environment, an alternative to laddering your portfolio that may be considered in the future is a "barbell" strategy.
Using a "barbell," the investor concentrates bond holdings at both ends of the spectrum. A high percentage of investments goes into short-term bonds, typically with maturities of a year or less, and a similar percentage goes into long-term bonds, typically with maturities of 20 to 30 years.
A barbell strategy is especially effective when there is uncertainty about whether interest rates are heading up or down. If they’re heading down, long bonds are a good investment. If they’re heading up, shorter maturities are better.
Concentrating investments on both ends of the spectrum returns your risk, whether rates go up or down.
Given that interest rates are at historic lows and that interest rates are expected to increase, this strategy is currently not recommended.
Remember that bonds are not without risk. An in-depth knowledge of bonds is needed to invest successfully long-term.
Bonds are not nearly as exciting as stocks, but, given recent market volatility, wouldn’t it be refreshing to have a little less excitement in your portfolio?
Brenda P. Wenning of Newton is president of Wenning Investments LLC of Newton. She can be reached at Brenda@WenningInvestments.com or 617-965-0680. For additional information, visit her blog at www.WenningAdvice.com.
Copyright 2010 The Daily News Tribune. Some rights reserved
From The Daily News Tribune published on Aug 15, 2010 @ 12:04 AM
Get some free education prior to investing in Bonds. Find out its latest news and updates in the current market. If you are ready, don't waste time, start investing!
Hedge Funds Crowd Into U.S. Bonds
By ALISTAIR BARR
U.S. Treasury bonds, often a top choice for risk-averse investors, are attracting more interest from hedge funds, according to a study released Wednesday by consulting firm Greenwich Associates.
Hedge-fund trading volume in U.S. government bonds surged in the past year. In 2009, hedge funds generated about 3% of trading in this market. This year, that share jumped to roughly 20%, Greenwich Associates said.
The move may be driven by two trends. Heightened sovereign-debt concerns may be creating more trading opportunities in the Treasury market. Hedge funds also may be responding to demands on the $1.8 trillion industry by institutional investors.
"Hedge funds over the past 12 months have been refocusing their attention onto more liquid products," Greenwich Associates consultant Tim Sangston said. "This change in approach reflects both shifts in investment strategies and the impact of liquidity demands on the institutions that supply a growing share of hedge-fund capital."
The Treasury-bond market is the most obvious example of this, but the trend can also be seen in the market for agency securities, which are backed by mortgage-finance giants Fannie Mae and Freddie Mac.
Hedge funds still make up a small part of the agency market, but their trading volume in these securities jumped by more than 60% from 2009 to 2010, Greenwich Associates said.
Hedge funds were hit hard by a wave of redemption requests triggered by the financial crisis in 2008. Many funds froze withdrawals, locking up investors' money for months.
Now, investors are pushing to be allowed to withdraw money more easily in times of market stress. To offer this, funds may have to keep more securities that can be sold quickly. Treasurys and agencies are among the most liquid securities.
Write to Alistair Barr at alistair.barr@marketwatch.com
From The Wall Street Journal published on AUGUST 13, 2010
U.S. Treasury bonds, often a top choice for risk-averse investors, are attracting more interest from hedge funds, according to a study released Wednesday by consulting firm Greenwich Associates.
Hedge-fund trading volume in U.S. government bonds surged in the past year. In 2009, hedge funds generated about 3% of trading in this market. This year, that share jumped to roughly 20%, Greenwich Associates said.
The move may be driven by two trends. Heightened sovereign-debt concerns may be creating more trading opportunities in the Treasury market. Hedge funds also may be responding to demands on the $1.8 trillion industry by institutional investors.
"Hedge funds over the past 12 months have been refocusing their attention onto more liquid products," Greenwich Associates consultant Tim Sangston said. "This change in approach reflects both shifts in investment strategies and the impact of liquidity demands on the institutions that supply a growing share of hedge-fund capital."
The Treasury-bond market is the most obvious example of this, but the trend can also be seen in the market for agency securities, which are backed by mortgage-finance giants Fannie Mae and Freddie Mac.
Hedge funds still make up a small part of the agency market, but their trading volume in these securities jumped by more than 60% from 2009 to 2010, Greenwich Associates said.
Hedge funds were hit hard by a wave of redemption requests triggered by the financial crisis in 2008. Many funds froze withdrawals, locking up investors' money for months.
Now, investors are pushing to be allowed to withdraw money more easily in times of market stress. To offer this, funds may have to keep more securities that can be sold quickly. Treasurys and agencies are among the most liquid securities.
Write to Alistair Barr at alistair.barr@marketwatch.com
From The Wall Street Journal published on AUGUST 13, 2010
Goldman Sachs Says Don't Be Afraid as Bonds Trade Over Par: Credit Markets
By Shannon D. Harrington - Aug 11, 2010 6:18 PM GMT+0800
The highest corporate bond prices in more than six years show investors reconsidering an aversion to buying debt trading above face value as the Federal Reserve is compelled to take more steps to boost a slowing recovery.
The average investment-grade bond price has jumped about 4.5 cents to more than 110 cents on the dollar in the past two months as yields fell 73.5 basis points to 3.929 percent, according to Bank of America Merrill Lynch index data.
With short-term interest rates near zero and the pace of an economic recovery slowing, investors may drive prices higher as they turn to credit markets to bolster yields, said Alberto Gallo, a strategist at Goldman Sachs Group Inc., the U.S. bank that makes the most revenue from fixed-income trading.
“Even if prices look high, the current search-for-yield environment may drive them even higher,” Gallo said yesterday in a telephone interview from New York. “Investors have been worried about high prices because buying bonds trading substantially above par exposes them to more losses if spreads widen. When you put more capital to work, your level of risk increases as well.”
Fed officials said yesterday that a “more modest” recovery than anticipated is prompting them to retain a commitment to keep their benchmark interest rate close to zero for “an extended period.” The central bank will maintain holdings of securities to prevent money from being drained out of the financial system it helped prop up after the credit seizure in 2008. The Fed will reinvest principal payments on its mortgage holdings into long-term Treasury securities.
Spreads Widen
Elsewhere in credit markets, the extra yield investors demand to own company bonds instead of government debt was unchanged at 175 basis points, or 1.75 percentage points, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index. The spread has narrowed 26 basis points since June 11. Average yields fell to 3.643 percent from 3.654 percent.
Yields on Fannie Mae and Freddie Mac mortgage securities that guide U.S. home-loan rates set record lows. The cost of protecting company debt in the U.S. and Europe from default rose to the highest in almost two weeks. Leveraged loans weakened and in emerging markets, spreads climbed the most this month.
Fannie Mae’s 30-year fixed-rate, current-coupon securities declined about 2 basis points from Aug. 9 to 3.43 percent as of 5 p.m. in New York, keeping pace with 10-year Treasuries after the Fed’s announcement, according to data compiled by Bloomberg. That’s down from this year’s high of 4.67 percent on April 5, and surpasses previous lows reached several times this year, most recently at 3.45 percent on July 30.
Not ‘Major’
“From a mortgage market standpoint, it’s not a major event, except to the extent that Treasury rates rally, it will mean mortgage rates will follow,” Mahesh Swaminathan, a mortgage-bond analyst at Credit Suisse Group AG in New York, said yesterday in a telephone interview. The U.S. central bank’s decision was not “really a surprise,” he said.
The yield on 10-year Treasuries dropped 4 basis points to 2.72 percent as of 11 a.m. in London, according to BGCantor Market Data, and earlier touched the lowest level since April 2009. The yield on the two-year note fell 3 basis points to a record low 0.49 percent.
Bank credit may come under pressure and profits could suffer for years as the Fed, Fannie Mae and insurers step up demands on lenders to take back faulty mortgages, according to Moody’s Investors Service.
Repurchase Requests
Repurchase requests tied to mortgages made during the housing boom are increasing and expenses are rising at U.S. banks, New York-based Moody’s said in a report. New pressure is coming from the Federal Reserve Bank of New York, which acquired stakes in mortgage securities when it helped salvage Bear Stearns Cos. and American International Group Inc. in 2008, the report said.
The cost of protecting European company debt from default rose to the highest in more than two weeks. The Markit iTraxx Europe Index of 125 companies with investment-grade ratings, which investors use to hedge against losses on corporate debt or speculate on creditworthiness, increased 3.75 basis points to 109.25, according to Markit Group Ltd.
The Markit CDX North America Investment Grade Index rose 2.55 basis points to 104.58 basis points in New York.
Asia Swaps
The indexes typically rise as investor confidence deteriorates and fall as it improves. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
Bonds from Chesapeake Energy Corp. and Anadarko Petroleum Corp., which each sold $2 billion of notes on Aug. 9, were the most actively traded U.S. corporate securities yesterday by dealers, Bloomberg data show. Oklahoma City-based Chesapeake, the second-largest U.S. natural gas producer, had 299 trades of $1 million or more, while Anadarko, the oil company based in The Woodlands, Texas, that owns a stake in BP Plc’s damaged Gulf of Mexico well, had 214.
Anadarko’s 6.375 percent notes due in 2017 that priced at par fell 0.19 cent to 99.813 cents on the dollar, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. Chesapeake’s $1.4 billion of 6.625 percent securities due in 2020 rose to 100.125 cents from par, Trace data show.
Leveraged Loans
The Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index fell 0.02 cent to 89.86 cents on the dollar. Loans have returned 4.16 percent this year based on the index, which tracks the 100 largest dollar-denominated first-lien leverage loans.
In emerging markets, spreads expanded 5 basis points to 263 basis points, according to JPMorgan Chase & Co. index data. That’s the biggest increase since relative yields on the debt climbed 7 basis points on July 28.
Declining interest rates and a savings rate that has reached the highest in almost 18 years may continue to fuel a reach for yield that has bolstered credit markets since 2009.
“Primary issuance is strong, but it’s a fraction of last year’s,” said Gallo, one of the strategists who wrote investors shouldn’t “be afraid of high prices” in a note to clients this week. “On the other hand, demand is closer to 2009, as shown by the $70 billion of inflows in investment-grade mutual funds, year-to-date. If investors get under-allocated in the primary market, they will eventually seek bonds in the secondary. High- priced bonds trading at a yield premium will soon look attractive.”
Default Risk
When prices are at or near face value, corporate bond investors typically look more at the excess yield that debt pays over Treasuries to determine whether the securities are cheap or expensive.
While the spreads on investment-grade debt have declined to 188 basis points from 600 basis points in March 2009, they’re still 56 basis points wider than in August 2007, when central banks globally pumped $135.7 billion into the banking system in an attempt to avert a growing crisis of confidence.
Investors may pay more attention to price as they stray higher from face value in part because they face greater losses if the risk of default increases. Even speculative-grade bonds now trade above par. Bonds rated in the two highest junk tiers are trading on average at 101.7 cents on the dollar, up from 97.1 cents on June 10, Bank of America Merrill Lynch index data show.
High-yield, high-risk debt is rated below Baa3 by Moody’s and lower than BBB- by S&P.
“There is that fear of a double-dip recession, and obviously you have a long way down from par if the outlook changes and the expectation becomes that default rates will rise,” said Martin Fridson, global credit strategist at BNP Paribas Asset Management in New York. “The other side is, I could eliminate that risk by not buying anything above par. But then you’re going to maybe be giving up at least a lot of current yield.”
To contact the reporter on this story: Shannon D. Harrington in New York at sharrington6@bloomberg.net
From Bloomberg News published on Aug 11, 2010 6:18 PM GMT+0800
The highest corporate bond prices in more than six years show investors reconsidering an aversion to buying debt trading above face value as the Federal Reserve is compelled to take more steps to boost a slowing recovery.
The average investment-grade bond price has jumped about 4.5 cents to more than 110 cents on the dollar in the past two months as yields fell 73.5 basis points to 3.929 percent, according to Bank of America Merrill Lynch index data.
With short-term interest rates near zero and the pace of an economic recovery slowing, investors may drive prices higher as they turn to credit markets to bolster yields, said Alberto Gallo, a strategist at Goldman Sachs Group Inc., the U.S. bank that makes the most revenue from fixed-income trading.
“Even if prices look high, the current search-for-yield environment may drive them even higher,” Gallo said yesterday in a telephone interview from New York. “Investors have been worried about high prices because buying bonds trading substantially above par exposes them to more losses if spreads widen. When you put more capital to work, your level of risk increases as well.”
Fed officials said yesterday that a “more modest” recovery than anticipated is prompting them to retain a commitment to keep their benchmark interest rate close to zero for “an extended period.” The central bank will maintain holdings of securities to prevent money from being drained out of the financial system it helped prop up after the credit seizure in 2008. The Fed will reinvest principal payments on its mortgage holdings into long-term Treasury securities.
Spreads Widen
Elsewhere in credit markets, the extra yield investors demand to own company bonds instead of government debt was unchanged at 175 basis points, or 1.75 percentage points, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index. The spread has narrowed 26 basis points since June 11. Average yields fell to 3.643 percent from 3.654 percent.
Yields on Fannie Mae and Freddie Mac mortgage securities that guide U.S. home-loan rates set record lows. The cost of protecting company debt in the U.S. and Europe from default rose to the highest in almost two weeks. Leveraged loans weakened and in emerging markets, spreads climbed the most this month.
Fannie Mae’s 30-year fixed-rate, current-coupon securities declined about 2 basis points from Aug. 9 to 3.43 percent as of 5 p.m. in New York, keeping pace with 10-year Treasuries after the Fed’s announcement, according to data compiled by Bloomberg. That’s down from this year’s high of 4.67 percent on April 5, and surpasses previous lows reached several times this year, most recently at 3.45 percent on July 30.
Not ‘Major’
“From a mortgage market standpoint, it’s not a major event, except to the extent that Treasury rates rally, it will mean mortgage rates will follow,” Mahesh Swaminathan, a mortgage-bond analyst at Credit Suisse Group AG in New York, said yesterday in a telephone interview. The U.S. central bank’s decision was not “really a surprise,” he said.
The yield on 10-year Treasuries dropped 4 basis points to 2.72 percent as of 11 a.m. in London, according to BGCantor Market Data, and earlier touched the lowest level since April 2009. The yield on the two-year note fell 3 basis points to a record low 0.49 percent.
Bank credit may come under pressure and profits could suffer for years as the Fed, Fannie Mae and insurers step up demands on lenders to take back faulty mortgages, according to Moody’s Investors Service.
Repurchase Requests
Repurchase requests tied to mortgages made during the housing boom are increasing and expenses are rising at U.S. banks, New York-based Moody’s said in a report. New pressure is coming from the Federal Reserve Bank of New York, which acquired stakes in mortgage securities when it helped salvage Bear Stearns Cos. and American International Group Inc. in 2008, the report said.
The cost of protecting European company debt from default rose to the highest in more than two weeks. The Markit iTraxx Europe Index of 125 companies with investment-grade ratings, which investors use to hedge against losses on corporate debt or speculate on creditworthiness, increased 3.75 basis points to 109.25, according to Markit Group Ltd.
The Markit CDX North America Investment Grade Index rose 2.55 basis points to 104.58 basis points in New York.
Asia Swaps
The indexes typically rise as investor confidence deteriorates and fall as it improves. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
Bonds from Chesapeake Energy Corp. and Anadarko Petroleum Corp., which each sold $2 billion of notes on Aug. 9, were the most actively traded U.S. corporate securities yesterday by dealers, Bloomberg data show. Oklahoma City-based Chesapeake, the second-largest U.S. natural gas producer, had 299 trades of $1 million or more, while Anadarko, the oil company based in The Woodlands, Texas, that owns a stake in BP Plc’s damaged Gulf of Mexico well, had 214.
Anadarko’s 6.375 percent notes due in 2017 that priced at par fell 0.19 cent to 99.813 cents on the dollar, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. Chesapeake’s $1.4 billion of 6.625 percent securities due in 2020 rose to 100.125 cents from par, Trace data show.
Leveraged Loans
The Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index fell 0.02 cent to 89.86 cents on the dollar. Loans have returned 4.16 percent this year based on the index, which tracks the 100 largest dollar-denominated first-lien leverage loans.
In emerging markets, spreads expanded 5 basis points to 263 basis points, according to JPMorgan Chase & Co. index data. That’s the biggest increase since relative yields on the debt climbed 7 basis points on July 28.
Declining interest rates and a savings rate that has reached the highest in almost 18 years may continue to fuel a reach for yield that has bolstered credit markets since 2009.
“Primary issuance is strong, but it’s a fraction of last year’s,” said Gallo, one of the strategists who wrote investors shouldn’t “be afraid of high prices” in a note to clients this week. “On the other hand, demand is closer to 2009, as shown by the $70 billion of inflows in investment-grade mutual funds, year-to-date. If investors get under-allocated in the primary market, they will eventually seek bonds in the secondary. High- priced bonds trading at a yield premium will soon look attractive.”
Default Risk
When prices are at or near face value, corporate bond investors typically look more at the excess yield that debt pays over Treasuries to determine whether the securities are cheap or expensive.
While the spreads on investment-grade debt have declined to 188 basis points from 600 basis points in March 2009, they’re still 56 basis points wider than in August 2007, when central banks globally pumped $135.7 billion into the banking system in an attempt to avert a growing crisis of confidence.
Investors may pay more attention to price as they stray higher from face value in part because they face greater losses if the risk of default increases. Even speculative-grade bonds now trade above par. Bonds rated in the two highest junk tiers are trading on average at 101.7 cents on the dollar, up from 97.1 cents on June 10, Bank of America Merrill Lynch index data show.
High-yield, high-risk debt is rated below Baa3 by Moody’s and lower than BBB- by S&P.
“There is that fear of a double-dip recession, and obviously you have a long way down from par if the outlook changes and the expectation becomes that default rates will rise,” said Martin Fridson, global credit strategist at BNP Paribas Asset Management in New York. “The other side is, I could eliminate that risk by not buying anything above par. But then you’re going to maybe be giving up at least a lot of current yield.”
To contact the reporter on this story: Shannon D. Harrington in New York at sharrington6@bloomberg.net
From Bloomberg News published on Aug 11, 2010 6:18 PM GMT+0800
Subscribe to:
Posts (Atom)