As advisors count down the short days of summer to an all but inevitable Federal Reserve interest rate hike, some are turning to fixed-income to prepare their ultra-high-net-worth clients for the increase.
Laura LaRosa, Glenmede Investment and Wealth Management's managing director and director of portfolio management, likes the high-yield end of municipal bonds right now. They are “very interesting picks with the right manager,” she said. “As a rule, we have been underweight bonds because the yields just have not been compelling.” The principal of the portfolio has to be protected, too, she added.
Most every government issuer's situation is unique these days, with credit ratings declining on some U.S. cities and states, including Detroit, Chicago and New Jersey.
“Investors don't want a manager that went long Puerto Rican bonds,” said LaRosa.
Tax-free munis are “the only area for true tax-exempt yields for our clients,” who have $40 billion in assets under Glenmede's management, she said. Assets are comprised of 28 percent family client deposits, with over $25 million and 43 percent foundations and endowments, for an average client balance of $55 million.
LaRosa expects a gradual Fed hike to affect the shorter end of bond durations. “I don't anticipate a rate rise across the curve. There is no inflation in the system and the dollar is strong.” Glenmede's average core bond duration is 4.5 years.
Cam Albright, who heads asset allocation at Wilmington Trust, is ready for a somewhat broader impact. “What happens in the Treasury market doesn't stay in the Treasury market,” he quipped. Muni curves price off its movements. If that yield curve flattens or rates move higher, there is a bigger impact on the shorter-term issues. “Duration positioning is really important,” he said. Income as opposed to total-return investors should not worry, he said. “They just need to be more defensive.”
Playing defense is harder since the financial crisis all but wiped out bond insurance, he noted. “People had a false sense of security,” said Albright, none of whose clients hold Puerto Rico bonds.
People used to insure bonds without thinking, but “those days are pretty well gone.” Now, “credit really does matter,” he said.
Covenants in bond offerings have grown critical. In a higher rate environment, massive “benefits that munis are not able to deliver become a much bigger problem,” said Albright. Citing Detroit and Atlantic City, he noted “people looking at getting cities on a better footing have not been very kind to bond holders. You don't want a situation where you're looking at bankruptcies protecting pensioners and taking it out on bond holders.”