Guidance

RESOURCES TO HELP SHAPE YOUR FINANCIAL FUTURE

Since the financial crisis of 2008, and the subsequent unprecedented monetary policy measures enacted by governments and central banks across the globe, interest rates have hovered at historically low levels. For many fixed income investors, this protracted period of extremely low rates has been a time of struggle. As the days of CDs and investment-grade bonds yielding 5% or more have become a thing of the past, investors—particularly retirees—are left wondering how best to generate sufficient income from their portfolios.

There are a variety of means for investors to consider in the context of their investment objective, while acknowledging that interest rates will not remain near zero forever. These can be viewed through the framework of a series of questions all investors should be prepared to answer.

How can I protect my portfolio from a rise in interest rates?
Unconstrained bond funds, also called “go anywhere” funds because they are not tied to any single fixed income sector, is one option to consider. These relatively new funds eliminate interest rate risk by maintaining shorter durations than core bond funds–an advantage if rates start to rise. Strategic Income funds can also be a solution. These often overlooked funds offer diversity, reduced risk and the potential for higher returns. Unlike single-sector funds, strategic income funds invest in several sectors and permit the portfolio manager to change the mix as conditions warrant. By diversifying across multiple sectors, investors’ risk is potentially reduced.

Investors should exercise caution when choosing an unconstrained or strategic income fund however, as it is a fast-growing universe and assessment of manager skill is critical. It is also important to note that a key measure of success for strategies of this sort is risk-adjusted return rather than return alone.

Do I have enough liquidity to take advantage of an eventual rise in interest rates?
Cash and short-term equivalents do not offer much in the way of yield. They do, however, give investors the necessary “dry powder” to take advantage of a more robust interest rate environment. For conservative investors willing to forgo current income—or unwilling to assume additional risk in the current environment to generate yield—keeping cash on the sidelines in order to invest in better opportunities that emerge in the future may be prudent.

Do I have an appropriate exposure to high-yield bonds?
High-yield bonds have been a tremendous investment since the financial crisis. The Barclays U.S. Corporate High Yield Index has produced an average annualized total return of 13.1% over the past five years and 9.0% in the last year.

However, as the stampede bond sell-off in the spring of 2013 and the poor showing of high-yield bonds in 2008 revealed, these bonds come with risk. Investors should be careful to avoid the temptation to “reach for yield” if it means exceeding their overall tolerance for risk.

Should I consider foreign bonds?
While prevailing rates in the U.S. are certainly low, there are opportunities available in other areas of the world for fixed-income investors to consider. As the chart above shows, 10-year sovereign debt yields in various regions of the world suggest that a broad range of returns is available overseas, albeit with commensurate risk.

Mutual funds with international bond and currency exposure can be an effective means of capturing this yield while providing diversification to help manage geopolitical and economic risk. One measure of the foreign bond market is the Barclays Global Aggregate Bond Index. It is a market value-weighted portfolio that includes government, corporate and other securitized bonds from the U.S., Europe, and Asia Pacific, with varying credit quality and maturities. Over the past five years, the index has produced an average annualized
total return of 4.2%. Moreover, the Index has produced returns similar to global equities over the past 20 years (as measured by the Dow Jones Global Total Stock Market Index), yet with only one-third of the volatility during that time.

These are just a few of the many questions to address when investing in today’s fixed income markets. If you are considering investing in bonds, or adjusting your current bond portfolio, we encourage you to contact a Financial Advisor to explore the best ways for you to improve your portfolio’s yield from fixed income investments.

 

Source: Bloomberg, investing.com. Data as of August 1, 2014