Investment Managers' Old News Still Profitable?
With municipalities squeezed by smaller tax bases, bond investors have been looking for new fields of play. Another bet losing its luster is sovereign debt. With European markets experiencing protracted volatility and uncertainty, many investors are avoiding the continent out of consideration of their blood pressure. A safer play throughout the euro sovereign debt crisis has been U.S. treasuries, but these low-yielding debts have hardly been worth anyone's while lately, with interest rates near zero. Indeed, treasury bills may even offer negative interest soon.
In 2011, municipal bonds were a better play, especially those tax-free investments that started to yield high interest. Some AAA-rated municipals were offering nearly 5 percent at the height of uncertainty last year, offering investors an attractive and tax-free play that became a bigger part of many investment banks' portfolios. The change in strategy at Goldman Sachs (NYSE: GS) helped lower their tax rate for last quarter, and what's good for the vampire squid is also good for individual investors.
Municipal bond yields are falling, making them less attractive as in the past, especially as municipalities' risk profiles fail to recover as quickly as their debt rates. Thus these once-safe bets are becoming a bigger danger while the reward isn't rising to match it. Bond players looking for higher yields will need to look towards more exotic bets to match the returns of the previous year.
There are a few reasons for the suggestion. Corporate bonds are outperforming federal government debt, and with European worries continuing to set the tone for bond markets, corporate bonds are beginning to look like a relative safe haven despite their high yields. Fidelity in particular recommends non-financial corporate bonds, which they prefer over traditionally solid bets on German, British, and American bonds.
Another good reason to look at corporate debt is the high piles of corporate cash that caused Ralph Nader to go against the rails in a recent CNBC interview. Many companies are swimming in cash, and private sector growth in several sectors, particularly the tech sector, has turned the market upside down in terms of risk. Formerly uncertain and untested stocks such as Google (NASDAQ: GOOG), Microsoft (NASDAQ: MSFT), and the behemoth Apple (NASDAQ: AAPL) have surpassed the quiet confidence of blue chips to be seen by some as more reliable than the bonds of Portugal, Italy, or Greece. When companies continue to turn profits quarter after quarter in times of high unemployment, public-sector austerity, and global economic malaise, it is difficult to consider them a dicier bet than bonds that see yields grow by several percentage points in one year.
At the same time, companies have followed individuals and governments in the move towards deleveraging. Debt has become less addictive as it was last decade, and companies like Cigna (NYSE: CI) and Macerich (NYSE: MAC) have looked at their debt profiles more critically than ever before. This is true across several sectors, as economic uncertainty has made companies proceed more cautiously.
As a result, mutual funds that invest in high-yield bonds have seen tremendous growth in recent years, such as the Forward High Yield Bond Institutional Fund (MUTF: AHBAX), which has a trailing return of 4.17 percent for the last year and over 17 percent for the last three years. With a one-year alpha of 5.39, the fund has done well considering its risk profile.
ETFs that invest in high yield bonds have also done well over the past three years, such as Barclays Capital High Yield Bond (NYSE: JNK), which returned over 20 percent annualized over the past 3 years and 4.7 percent over the past year. The fund is young, having been born in November 2007, but its performance has been strong in a time when corporate bonds have performed fairly in a largely uncertain market.
The strong results in corporate and high-yield bonds point to one flaw in the recommendation towards corporate bonds: we already knew this. BLK and friends are about three years late to the corporate-bond party, although their confidence that the trend will continue should make investors look again at the high-yield bond market.
Another powerful play ignored by the big boys is an investment in companies that profit on the spread between low short-term Treasuries and long-term bonds. The high-profile sector in this market is REITs, many of which maintain a high yield that may eclipse their risk. Nonetheless, these companies remain risky, particularly those that do not invest in government-backed debt or those that are heavily leveraged themselves. Likewise, REITs were supposed to have a strong year in 2011 for similar reasons, but fell in part due to fears about bonds in general after the historic downgrade of American debt.
Junk bonds, REITs, and corporate debt are high yielding for a reason: they are often not safe. However, they may be yielding more than their risk profile warrants, and this may prove to be a common theme for 2012. Investors might want to consider past performance before dipping their toes into corporate bonds, but they also may have little choice if they want to play the bond market anytime soon.
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