The Increasing Risk in Owning Bonds
The Fixed Income market has been a tough place to find much value for far longer than I can remember. And yet, that hasn’t stopped the returns from being nothing short of spectacular. In fact, it’s not hard to find securities that have outperformed equities, and most would agree that it’s been a surprisingly good year for stocks.
Take the iShares Investment Grade Bond ETF (LQD) for instance. Up 10.5% year-to-date, for high grade bonds debt. The current yield to maturity on the portfolio is 2.89%, and a good part of the return for the year has come from price appreciation of the underlying bonds as the Fed’s relentless buying of government and mortgage debt has drawn investors to bid up the prices of other fixed income securities. If LQD returns 10.5 over the next year, 7.6% of that return will have to come from price gains which, given its effective duration of 7.8 means the yield to maturity will need to fall to under 2%.
The JPMorgan Emerging Market Bond Fund (EMB) has generated 14.5% so far this year, only 2% or so less than the S&P500. The yield on this portfolio has drifted down to 4.1%. For EMB to return 14.5% over the next 12 months, the same Math as in LQD means that, with an effective duration of 7.7 the yield to maturity will need to fall to 2.75%.
Even more striking has been the performance in some of the closed end funds that invest in senior loans. We’ve liked the ING Prime Rate Trust (PPR) for quite some time, but evidently we’re not alone for it currently trades at a 4% premium to NAV. PPR has returned a staggering 28% so far this year as investors have piled into bank debt and high yield in general.
There’s never any easy money to be made, but none of these investments appears that compelling today. Earning the current yield would seem to be the best plausible outcome on LQD and EMB. This morning’s Employment report was also reasonably positive, with the Unemployment rate falling below 8% for the first time in over three years. We’ve owned these securities in our Fixed Income Strategy but recently exited. The risk/return just doesn’t appear attractive, though bonds have looked expensive for a long time with barely a pause in the march to ever lower yields.
The information provided is for informational purposes only and investors should determine for themselves whether a particular service, security or product is suitable for their investment needs. The information contained herein is not complete, may not be current, is subject to change, and is subject to, and qualified in its entirety by, the more complete disclosures, risk factors and other terms that are contained in the disclosure, prospectus, and offering. Certain information herein has been obtained from third party sources and, although believed to be reliable, has not been independently verified and its accuracy or completeness cannot be guaranteed. No representation is made with respect to the accuracy, completeness or timeliness of this information. Nothing provided on this site constitutes tax advice. Individuals should seek the advice of their own tax advisor for specific information regarding tax consequences of investments. Investments in securities entail risk and are not suitable for all investors. This site is not a recommendation nor an offer to sell (or solicitation of an offer to buy) securities in the United States or in any other jurisdiction.
References to indexes and benchmarks are hypothetical illustrations of aggregate returns and do not reflect the performance of any actual investment. Investors cannot invest in an index and do not reflect the deduction of the advisor’s fees or other trading expenses. There can be no assurance that current investments will be profitable. Actual realized returns will depend on, among other factors, the value of assets and market conditions at the time of disposition, any related transaction costs, and the timing of the purchase. Indexes and benchmarks may not directly correlate or only partially relate to portfolios managed by SL Advisors as they have different underlying investments and may use different strategies or have different objectives than portfolios managed by SL Advisors (e.g. The Alerian index is a group MLP securities in the oil and gas industries. Portfolios may not include the same investments that are included in the Alerian Index. The S & P Index does not directly relate to investment strategies managed by SL Advisers.)
This site may contain forward-looking statements relating to the objectives, opportunities, and the future performance of the U.S. market generally. Forward-looking statements may be identified by the use of such words as; “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting a portfolio’s operations that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involves a number of known and unknown risks, uncertainties and other factors, and accordingly, actual results may differ materially from those reflected or contemplated in such forward-looking statements. Prospective investors are cautioned not to place undue reliance on any forward-looking statements or examples. None of SL Advisors LLC or any of its affiliates or principals nor any other individual or entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date that they were made. r
Certain hyperlinks or referenced websites on the Site, if any, are for your convenience and forward you to third parties’ websites, which generally are recognized by their top level domain name. Any descriptions of, references to, or links to other products, publications or services does not constitute an endorsement, authorization, sponsorship by or affiliation with SL Advisors LLC with respect to any linked site or its sponsor, unless expressly stated by SL Advisors LLC. Any such information, products or sites have not necessarily been reviewed by SL Advisors LLC and are provided or maintained by third parties over whom SL Advisors LLC exercise no control. SL Advisors LLC expressly disclaim any responsibility for the content, the accuracy of the information, and/or quality of products or services provided by or advertised on these third-party sites.
All investment strategies have the potential for profit or loss. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be suitable or profitable for a client’s investment portfolio.
Past performance of the American Energy Independence Index is not indicative of future returns.
Leave a ReplyWant to join the discussion?
Feel free to contribute!