4 things every bond investor should know
Warren Buffett is slamming bonds. Boston-based asset manager GMO, co-founded by legendary investor Jeremy Grantham, is running out of words to describe how much it hates fixed income. And BlackRock (BLK) CEO Larry Fink says investors should have 100 percent of their money in stocks.
Strong words from smart men -- but that doesn't mean you should bail out of bonds and blow-up your long-term asset allocation plans, says George Rusnak, national director of fixed income at Wells Fargo (WFC) Wealth Management.
Bonds still provide investors with a host benefits, including non-correlation with other assets, a steady stream of income and an increased assurance of getting your principal investment back, Rusnak writes in a new note to clients.
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"By forgoing the fixed income asset class altogether and focusing on equities, investors will create a less diversified portfolio by effectively 'putting all their eggs in one basket,'" says Rusnak. "This would be counter to the normal benefits of diversification."
The importance of a dedicated bond allocation was abundantly evident in 2011 when global equities were flat or down but most bond indexes posted strong returns. "Additionally, many clients utilize the income streams from their fixed income investments to cover everyday expenses," Rusnak notes. True, stock dividends can serve the same purpose, but they can change over time and periodically may yield less than fixed income.
"Finally, the comfort of knowing that you'll most likely receive your original principal investment, and the precise time you'll receive it, allows investors to better plan for their short-term and long-term financial needs," Rusnak says.
Be that as it may, yields are indeed pathetically low and any eventual upturn in interest rates will punish bond investors. With that in mind, Wells Fargo Wealth Management outlines four key strategies for investing in fixed income:
Diversify income streams. Look for opportunities in emerging-market debt as well as corporate and high-yield bonds that may offer yield cushion and capitalize on growth. Yield premiums in the emerging markets may offer opportunities for U.S. investors seeking diversification and enhanced income. In the U.S., Wells Fargo Wealth Management expects both investment-grade and high-yield corporate bonds to perform well in the current environment of slowly improving economic growth and improving credit fundamentals.
Seek shorter durations. Wells Fargo Wealth Management has removed its long-term bond allocation to emphasize its concern over interest-rate risk for the longer term. Select short- and/or intermediate-weighted issues whenever possible. Interest rates will eventually begin to rise, and investors should be positioned to take advantage of increasing bond yields when they materialize, Wells Fargo says.
Utilize defensive structures. Premium coupon bonds with shorter call features offer a bit more defensive positioning in the event that interest rates rise. Avoid long-term bonds selling at par, and short-term high premium bonds, as the possibility for principal loss of these types of issues is increased should rates begin to rise.
Don't chase performance. Although Wells Fargo Wealth Management doesn't recommend timing the market, it cannot overlook the fact that the broader municipal market indexes were up more than 11 percent in 2011 and are currently up more than 2 percent year-to-date. Nevertheless, caution is warranted in the short term with this asset class especially farther out on the curve, Wells Fargo advises.