Time to Bail Out on Treasurys?
US Treasurys have been a great ride for the past half a decade, but for those starving for yield, the end of the line may be here.
“Investors have become frustrated because the returns to savers from conservative investments like Treasurys have become negligible,” said Larry Luxenberg, a financial planner in New City, N.Y. “In some cases, returns are even negative.”
Some investors “have scared themselves into demanding higher negative returns,” said Aaron Skloff, CEO of Skloff Financial Group in Berkeley Heights, N.J.
He notes, for example, that some banks charge fees “simply to maintain an account, more than wiping out the miniscule yields they offer.”
Skloff also notes that adjusting for current and expected inflation rates, developed-market government bonds (like U.S. Treasurys) provide negative yields to maturity.
Even yields on 10-year Treasury Inflation-Protected Securities, TIPS, have been negative since the fourth quarter of 2011, implying that “investors are paying higher prices for the relative safety of these investments,” Neuberger Berman said in a recent report on Treasurys.
Money market funds are hardly the answer. They’re yielding just a couple of basis points, according to Bankrate.com. Returns on CDs are only a shade better.
According to a recent commentary by Rick Rieder, BlackRock's, CIO for fundamental fixed income, “Investors will have to learn how to navigate shorter economic and market cycles, as well as contend with persistently lower rates, which are both likely to be hallmarks of the economic and investment landscape for some time to come.”
So what’s a fixed-income investor to do?
There’s always municipal, corporate and sovereign debt, all of which are accessible through a variety of low-cost exchange traded funds.
“We’ve seen a lot of fund flows into high-yield corporate bond funds and emerging market bond funds, two real hot areas this year,” said Miriam Sjoblom, associate director of fund analysis at research firm Morningstar.
Another popular area, she says, has been high-yield muni bond funds, which invest in lower-quality credits.
Muni bond funds in particular have been sturdy for two years, according to Morningstar, but some analysts say they may be too expensive now.
“There’s been a ton of flows into municipal bond funds, and that’s been driving the prices up, so returns have been good,” Sjoblom said. “Munis now look pretty expensive. The yields are at all-time lows, so while there’s some long-term merit to munis, investors should be cautious.”
Nevertheless, Thornburg Investment Management, which holds several municipal-bond funds, generally thinks munis are a reasonable alternative today, and it is especially positive on revenue-type munis over general obligation bonds.
With respect to munis, “Investors should look particularly at their own tax rate and the tax-adjusted rates offered and compare them with alternatives in the taxable fixed-income market,” said Lon Erickson, portfolio manager of fixed income at Thornburg.
The high-yield, or junk, bond sector has been an attractive pit stop recently for many investors.
“Despite a less-than-robust economy, the high-yield default rate has been a better-than-expected mere 2 percent for the trailing 12 months,” said Skloff, referring to a new report from Fitch Ratings.
“Some managers are telling us that although the trend upwards in the high-yield sector is likely to be with us for some time, high-yield tends to experience losses in the short term,” said Sjoblom. She noted, for example, that the Barclay Capital High-Yield Bond Index yielded 8.4 percent in early 2012, and currently yields around 7 percent.
“Already that index has gained 10.4 percent year to date,” Sjoblom said. “You can only generate returns in excess of your income for so long.”
And there’s no shortage of corporate bonds, as companies take advantage of those low interest rates.
JP Morgan was among the big names to ply the market in August, selling $2.5 billion of 2 percent, five-year bonds, versus a quarter of 1 percent for two-year Treasury notes.
You can also get higher yields today in selected emerging markets. Some countries in Asia and Latin America, according to Morningstar, have healthier financial conditions and better prospects than the U.S., Japan or Europe.
Skloff said some emerging markets are good bets for bonds, even stocks, currently, “particularly if the recent strength in the U.S. dollar reverses,” which would make U.S. exports cheaper on world markets.
In many of these fixed-income choices, you may get slightly higher yield today, but it comes with greater risk, Morningstar warned. “Already, many of these sectors look expensive,” said Sjoblom.
“Whether this is a ‘bond bubble’ has yet to be determined,” said Luxenberg, but some on Wall Street say get used to a new world of fixed income.
Said BlackRock Capital in a recent note: “Investors will have to learn how to navigate shorter economic and market cycles, as well as contend with persistently lower rates, which are both likely to be hallmarks of the economic and investment landscape for some time to come.”