People usually buy fixed-income investments to add stability to a portfolio in addition to collecting regular income – but that strategy has backfired this year. Funds tracking the US bond market are down about 16%, their worst performance in decades. And the long-standing US Treasury has rallied about 34%, with the S&P 500 index down 21%.
Experts say it is not surprising that many people are running away from the bond market, but those investors are missing some key points. The market can no longer break away from its cyclical lows. And even if it doesn’t recover quickly, bondholders will continue to enjoy a decent stream of interest payments.
In addition, yields have risen “so ruthlessly,” says Mike Mulach, a senior manager research analyst at Morningstar Inc., it’s a good time to lock in rates much higher than what’s available in recent years. He continued: “This is a tremendous opportunity.”
Market professionals, however, say that the market is highly risky, so investors seeking income need to be cautious. Here are some ways to get low-risk income:
1. Hold an Individual Bond to Maturity
Bond prices move inversely to yields, so as the Federal Reserve raises rates to offset slow growth and inflation, most bonds have lost principal value — at least on paper. But, barring the default, a person who holds the individual bond to maturity will get back the initial outlay as well as interest. The caveat is that there is some complexity to choosing individual bonds, so it can be helpful to work with an advisor or broker when purchasing them.
Some bonds issued by state and local governments now yield about 4%, which is well above the year-ago level, notes Jason Ware, a bond underwriter and head of municipal business at Distributor InsperX. Because the interest may be exempt from federal and state taxes — depending on the type of bond and where an investor lives — this can mean that the tax-equivalent yield for those in the top tax bracket can be as high as 8%. Yes, they say.
2. Focus on Total Return, Not Just Yield
Those investing less often choose intermediate-maturity bond funds, which are designed to provide broad market exposure and may require an initial outlay of only $1,000.
Those funds have been slammed because they have a lot of rate-sensitive bonds such as Treasuries and other highly rated securities (generally speaking, the longer duration and higher ratings are, the more rate-sensitive bonds are) and unlike individual bonds – There is no final maturity.
But performance is expected to improve, and “it’s starting to look somewhat compelling” that core US fixed income has a worthwhile allocation, says Jeffrey Elswick, director of fixed income at Texas-based Frost Investment Advisors. His reasoning: Once the Fed cuts return rates, which some market watchers predict could happen as early as next year, many intermediate bonds that currently have large principal losses will, at least partially Will rebound in value from this, providing opportunity for capital gains.
Experts say that intermediate funds usually have maturities of around four to 10 years, so a less risky way to adopt such strategies is to plan on holding them for at least several years. A rule of thumb for choosing a bond fund is that investors should match the fund’s rate sensitivity, or duration, as shown on its fact sheet, with their own investment time horizon. Rick Lear, a portfolio manager in Dallas, suggests looking at funds from a total-return perspective—the potential principal loss or gain in addition to the yield—and considering the potential impact on performance.
Intermediate funds rated highly by Morningstar have Pimco Total Return (PTTAX), yield more than 3%, charge 0.80% in expenses and are down about 17% this year. One exchange-traded fund option to consider is the Vanguard Intermediate-Term Bond (BIV). It charges 0.04% in expenses, yields 4.9% and is down about 16%.
3. ‘Ladder’ Variation
A more conservative, short-term strategy that may appeal to someone with cash, but who is still too nervous to do much in the bond market, may be buying short-term securities and selling them when they mature, at higher rates. The proceeds can be reinvested. , It is a variation on a strategy known as laddering – owning a single type of bond with maturity over several years – and can work well as long as yields still seem to be rising. .
For example, using a brokerage or TreasuryDirect.gov account, one can purchase eight-week Treasury bills — which yield about 4% — and continue to reinvest in those shorter maturities until such time as it appears. It doesn’t happen that rates have stabilized. The investor can then lock in the yield for a longer period of time by transferring to two-, three- or five-year Treasury notes, where the yield is also attractive. This kind of approach enables the investor to get better returns from a savings account while also seeing how events unfold.
The challenge is timing, says John Kershner, a senior portfolio manager at Janus Henderson Investors. Even professionals cannot estimate rates accurately. Mr. Kershner says inexperienced investors may be better off owning a floating-rate fund, whose yields automatically go up or down with market rates. Other types of bond funds typically own securities with fixed coupons, which lose the principal value when rates move upward.
4. Higher float as rates increase
Many floating-rate funds own bank loans made to companies with low credit to enjoy higher rates. As rates rise, the fund’s yield moves upward and is now around 4% or more. But the managers of some of these funds carry more credit risk than others, says Morningstar’s Mr. Mulach, so fear of a recession could affect performance.
According to Morningstar, Fidelity Floating Rate High Income (FFRHX), yielding around 8%, is a more risk-averse option, giving the fund a Silver rating, its second-highest rating. An investor can also choose a floating-rate fund that holds investment-grade securities, such as the WisdomTree Floating Rate Treasury ETF (USFR), yielding around 3%.
Once rates pass through a cyclical peak, says Mr. Elswick in Frost, the floating-rate yield will slowly start to decline. He suggested trimming these types of holdings “after the Fed hits the pause button” when the rate rises.
5. Limit both credit and rate risk
Funds that focus on the one- to three-year segment of the investment-grade corporate debt market are worth considering, says Lawrence Gillum, fixed-income strategist at LPL Financial. While they too have been hurt this year, the damage is minimal as they focus on less-rate-sensitive maturities. Experts say performance is likely to improve as their managers replace maturing securities with new securities issued at lower prices and higher returns.
Mr. Gillum prefers proactive managers, whom he says can sift through a diverse market for the best opportunities. But such funds also come in low-cost ETF format.
The SPDR Portfolio Short Term Corporate Bond (SPSB) ETF — around 5% — this year yields more than 5% and charges just 0.04% in expenses. Short-term corporate bonds offer “very good compensation” based on yields and their limited rate risk, says Matt Bartolini, head of SPDR Americas research at State Street Global Advisors.