This piece touches on four major debt classes in order to provide investment committees with a few ideas in order to dissect their current positions and how they may navigate them going into 2013.
Zenith Portfolio Strategies Fixed Income thoughts
These are starting points to dissect the fixed income segment of your firms portfolio.
1. Treasury Bonds Since the BarCap Aggregate US holds a significant portion of Treasury debt, it would be worthwhile to assess your funds exposure to this debt class. While it could trend down in yield as a risk-off trade or inflation deteriorates into deflation, it is simply not worth the risk.
There is potential to take gains if needed and reposition into more favored asset classes.
2. Investment Grade Debt-LQD is an ETF that represents a large portion of the investment grade universe and yields approximately 3.58% based on the most recent distribution. The 10-yr treasury has a yield of 1.57% so a spread of approximately 2%
Recent readings of CPI have been year over year at or above that yield. We suggest including investment grade debt as a candidate for reducing as clients need to take gains. Reposition into more favored asset classes.
3. High Yield– Loomis Sayles’ Matt Egan issues a bit of a warning on high-yield, noting their only upside at this point is the coupon (not something to sneeze at). If prices rise any further, expect issuers to refinance into lower rates. The downside is defaults, and with the default rate as low as it currently is, they can only go in one direction.
HYG-The ETF that represents a broad segment of the high yield market yields approximately 6.17% based on the most recent distribution. That is 460 basis points above the 10-yr treasury. A real yield of 2.6%.
We suggest an examination of your fund holdings to determine the quality of the underlying pool of high yield debt and determine if you are being compensated for the credit risk inherent in the portfolio. The broad market may be fairly valued at best while there are some undervalued segments that an astute manager can focus.
This would be an excellent time to compare fund for a potential swap into a potentially better positioned fund.
4. Mortgage debt- This is the time after such a strong run to access the underlying breakdown among Agency and non-agency debt. While both have had strong returns, the non-agency space seems to hold the best potential for higher yield. On a duration adjusted basis a portfolio based on agency debt(Fed support) and non-agency debt holds more appeal than a lot of the investment grade universe. There are headwinds if housing softens considerably.
This is an ideal time to engage your bond fund managers in a serious conversation on how they are navigating the risks inherent in the non-agency space. Alt-A and sub prime hold potential if the risks are understood.