While an exaggeration,  it seems that no one likes bonds. It is understandable to some degree given the large % upward surge in yields since May when the Federal Reserve its intent to taper its purchases of Treasury Notes and Mortgage Backed Securities. It is important to note that they are likely to simply reduce the amount of purchases in both these categories but they will still be net buyers of an enormous magnitude. They will still be buying 65-70billion worth of securities. In some ways, we believe that they are trying to keep the % of each that they buy about the same.

This is NOT a slam on the brakes operation where the Fed will be a net seller within months. The pace of taper will depend a lot on inflation and employment tied to the economy and if deflation potential becomes real and a real credit crunch is starting to percolate, they will not only no taper, they will be net buyers of everything in site.

The potential opportunities lie outside of Treasuries as they will likely be the most volatile given the direct impact from Fed action that is realized or anticipated.  Here are three ETFs that represent distinct areas of the debt market with all possessing similar duration in order to make a reasonable comparison.

IEF- I-Shares 7-10 yr Treasury Bond

SEC Yield 2.42%   Duration 7.57

The amount of yield(reward) to duration(risk) is .31.

It is down 9.534% since May 2013

Credit quality AAA

MUB- I-Shares National AMT Free Muni Bond

SEC Yield 3% Duration 7.37

The amount of yield(reward) to duration(risk) is .47.

Credit quality “A”

LQD-I-Shares I-Boxx $ Investment Grade Corporate Bond Fund

SEC Yield 3.72% Duration 7.37

The amount of yield(reward) to duration(risk) is .50

Credit quality “BBB”

We believe that municipal debt represents a reasonable opportunity given the rise in yields, the high credit quality and the yield to duration ratio much higher than treasuries and comparable to investment grade debt with higher credit quality.

Additionally, the muni/treasury yield ratio has been historically around 93% and now is approximately 120% which bolsters the case for municipal debt.

Given the massive selling in fixed income across the board, we believe that investors should begin to find a quality open end manager with solid credit selection skills as well as a closed end fund that is trading at a discount and whose manager has a solid track record of alpha production and begin to build a position in this asset class.

Tom Koehler-CIO

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