The bond market for the most part has done reasonably well this year as the broad US market has provided a return of approximately 3.68%.

This is the return on the Barclay’s US Aggregate and one instrument that represents this large market is the I-Shares ETF (AGG). We have written in the past about using passive ETFs as a strategic holding. Generally we have viewed them with caution at best given the limitations that most possess.

A placement in this product provides you with exposure to an investment grade portfolio with most of the credit at the top end of this spectrum. This is due in large part to the heavy weight to Treasury Securities. They comprise 37% of the portfolio while Mortgage Backed Debt is about 27%. That is a large bet on steady to declining interest rates as the overall duration is 5.18 through June 30th.

As a review, this means that the fund can go down 5.18% for every 100 basis point move up in interest rates. 200 basis points and clients will wonder what happened to their “safe” money.

Even if rates remain absolutely steady, a yield of 2%, is hardly compensation for a fund with this amount of interest rate risk and the potential for a credit shock that would send the prices of even investment grade debt tumbling.

We feel at Zenith that it is difficult to paint a broad brush across the entire bond market for a strategic placement as their are a lot of sub-segments within this market.

Treasuries, mortgage-backed debt, municipal bonds and high yield are just a few in a very dynamic and diverse market. We recommend that firms build out their fixed income exposure with a group of managers with unique insight and management style.

While this will not come close to guaranteeing a full proof way to avoid losses in bonds, it will enable your firm to capture the value added provided by top managers in various categories.

Next week we will present a couple managers who we feel should be up for consideration given their management skills and risk control.


Tom Koehler-CIO