Invest now based on now
By Doug Drabik, Fixed Income, Raymond James
April 4, 2016
As a lifetime Cub fan, I’ve endured a lot of “this is our year”, a very optimistic and fun start of the season ritual proclaiming that this year, is indeed different, and that the Cubs actually might could/should have a chance run at the World Series. Usually they’re out of contention by August. I bring this up because bond market yields have behaved much like the Cubs have for years now. It seems like economists, strategists, advisors and investors make their ritual claim that “this is the year that interest rates will rise with fervor”, changing the 34.5 year general interest rate decline.
It is very logical to recognize that when the market is at historical lows, that perhaps there is a higher likelihood for interest rates to reach higher levels. However, is this really sound logic? In hindsight it is really easy to point out that following this logic has been a very costly toll to portfolio income. In hindsight, duration products have soundly outperformed portfolios positioning with bonds designed to take advantage of rising interest rates. Bonds have taken a beating in the media and with known and respected investment experts because this was the year they are going to get crushed (in price) as interest rates rise. In anticipation of this “certainty”, investors have tried to substitute the real certainty of bond income, cash flow and maturity with surrogate asset classes. It hasn’t worked out too well.
The point is that all this is very clear “in hindsight”. For most bond investors, total return is not the primary component, income is. A typical investment portfolio is composed in a 70:30 or 60:40 format. In other words, 70% equity (poised to push growth) and 30% bonds (poised to protect principal and provide certain income). If one thing is clear, it is difficult to predict the future and is not a good risk to gamble with the 30% or 40% of the portfolio dedicated to income based on “this is the year that interest rates will rise”.
Invest for today, based on portfolio needs and current market conditions. Too often, investors reach for yield or change portfolio structure centered on what might happen. As stated, most portfolios are composed of ratios similar to 70:30 (equity/bond). Portfolios can benefit by positioning bonds in the belly of the curve, that point where spreads/yields are capitalized versus market risk. Recently for example, municipal bonds have a good risk/reward ratio in the 10 year to 20 year maturity range and corporate bonds in the 3 year to 12 year maturity range. In addition, since the majority of assets are typically in equities, bonds (long-duration, low correlation) may be an excellent hedge to equity volatility. Please contact your financial advisor for Fixed Income Service’s recent article entitled For Equity Investors, Duration is Your Friend.
The Cubs kiss of death this year may be their appearance on the cover of Sports Illustrated. Don’t let your portfolio experience a kiss of death based on someone’s prediction of the future. Invest based on purpose and the known current market attributes.
