Bonds and Fixed Income

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>>> Why It’s Time to Rethink Bonds


Barron's

by Gail MarksJarvis

June 7, 2020


https://www.barrons.com/articles/with-rates-so-low-income-investors-need-to-rethink-bonds-51591404975?siteid=yhoof2&yptr=yahoo


Already-beleaguered income investors are facing a tough decade. Ten years ago, investors were bemoaning a 3.8% yield on the 10-year Treasury, because a decade before that, they were yielding 6.4%. Recently, 10-year Treasuries yielded 0.88%.

“We are at a pretty bleak starting point for income investors,” says Michael Fredericks, manager of the $16 billion BlackRock Multi-Asset Income Portfolio fund (ticker: BAICX).

Fredericks has analyzed decades of bond performance using the Barclays Aggregate Bond Index, or AGG, and found that the 10-year Treasury yield at the start of a decade gives a reliable clue to what’s to come during the next nine years. The starting Treasury yield is almost identical to the annual total return over the decade. For example, the 10-year Treasury was yielding 3.8% on Jan. 1, 2010, and the annualized return through the decade was 3.75%. “This suggests that with the 10-year Treasury yielding 0.8% today, the returns for the AGG over the next 10 years will likely be incredibly low,” he says.

“Advisors should be telling their clients that they aren’t going to generate the income they have in the past from Treasuries, or even corporate or high-yield bonds,” adds Adrian Cronje, chief investment officer of Atlanta financial advisory firm Balentine.

Investors—especially retirees and other conservative investors—need to shift how they view bonds. Instead of relying on bonds for income, investors should embrace bonds as ballast. That means settling for low yields from Treasuries and high-quality corporate and municipal bonds, while tapping total return in stock and bond portfolios for income.

Barron’s spoke to advisors, analysts, and fund managers to assess the best strategy for bond investors today. Here’s what they said.

Don’t overdo risk. Investors have gone further out on the risk curve, allocating larger portions of their portfolio to high-yield, emerging-market debt, and bank-loan funds. That risk taking hurt badly in the coronavirus market rout between Feb. 19 and March 23. Among some of the biggest exchange-traded funds, the iShares iBoxx $ High Yield Corp Bond (HYG) plunged 22%; the Invesco Senior Loan (BKLN) fell 21%; the iShares Preferred and Income Securities (PFF) lost 27%; and the (ICVT) dropped 24%.

“Most investors don’t need an allocation to bank loans, preferred stock, or convertibles,” says Morningstar analyst Alex Bryan.

One ETF, such as the iShares Core Total USD Bond Market ETF (IUSB), which invests in Treasuries, mortgage-backed securities, and investment-grade and high-yield bonds, could offer enough diversification. Alternatively, Bryan suggests mimicking the makeup of that fund with more specific ETFs, to more easily add or reduce positions in, say, high-yield.

Don’t ignore Treasuries. Yes, Treasury bonds are yielding next to nothing, but yields drop when prices rise—which means investors can still find that bonds offer steadiness, and possibly positive returns, when stocks fall. “I’m not using corporate bonds at the moment,” says Sue Stevens, an advisor in Deerfield, Ill. “The bond portion of a portfolio should just be safe.” The Vanguard Intermediate-Term Treasury ETF (VGIT) has gained 7.3% so far this year, Stevens notes, while the Vanguard S&P 500 ETF (VOO), is down more than 2.5%.

If the economy weakens and the Federal Reserve lowers interest rates, both long-term and intermediate-term ETFs will likely have nice gains. In a report last week, Bank of America Securities economists wrote that they expect the Fed to guide rates lower in September, “once the initial bounce from reopening subsides and it becomes apparent that the economy is in for a slow and bumpy recovery.” That could make Treasury bonds maturing in five to seven years a sweet spot for investors: Intermediate-term Treasury ETFs, such as the Vanguard Intermediate-Term Treasury ETF (VGIT) or the iShares 3-7 Year Treasury Bond ETF (IEI), could gain value.

Worried about rates rising during a recovery? Stick with shorter-term Treasury funds, such as the iShares 1-3 Year Treasury Bond (SHY). Financial planner Lewis Altfest advises some people to park cash in money-market funds or certificates of deposit for a couple of years—yields are not much lower than Treasuries, and there is little to no risk if rates rise.

Beware the urge to bargain-hunt. There aren’t many bargains out there. Spreads, the difference between yields on investment-grade corporate bonds and Treasuries with the same duration, are just 5% below their highs for the year, notes DoubleLine deputy chief investment officer Jeffrey Sherman. One of the biggest corporate bond ETFs, iShares iBoxx $ Investment Grade Corporate Bond (LQD), plunged 17%, but rebounded sharply and is up 5% year-to-date.

In the March decline, it was possible to pick up high-quality corporate bonds at ultracheap prices, but those opportunities have passed, says Warren Pierson of Baird Funds. There is still “reasonable value in the market,” he says, but fund managers have to hunt for it. Even high-yield bonds have recovered much of their losses. The iShares $ High Yield ETF is only down 2.3% for the year despite a loss of 21.5% just a few months ago.

Sherman says that with the Fed purchasing ETFs that invest in both high-yield and investment grade bonds, investors have begun feeling inappropriately safe: “The Fed is not guaranteeing default positions.”

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