The stock market's daily gyrations hog so much attention that it's often easy to lose track of what's happening in the bond market. That's too bad, for the fixed-income arena is a market of many micro markets, as any good advisor knows. Depending upon the interest-rate environment, the spread between taxable and tax-exempt yields, and the strength of the economy, advisor may prefer municipals, short-term bonds, long-term bonds, corporates, Treasuries or some mix of the above.
Where are advisors finding opportunities in the current bond market? After all, even the most equity-oriented advisors will recommend some bonds for a client's portfolio, and being in the right spot in the fixed-income market can add incremental return.
A brief survey of advisors and one fund manager showed that there isn't much dissent about where the economy is headed or where interest rates are going-the answer is upward for both. What is interesting is that this consensus view resulted in three somewhat different fixed-income portfolios.
The Long Corporate Portfolio
Virtually all observers agree that corporate bonds are where it's at. In a recent commentary, fixed-income manager Dan Fuss of Loomis Sayles writes, "From fundamental, technical and valuation perspectives, the corporate bond market looks to us that it is ready to run, but not sprint, to higher returns."
Among the reasons Fuss likes corporate bonds are: One, yields on corporate bonds are historically high relative to Treasuries, making corporates a comparative bargain. This is especially the case on the longer end of the yield curve; as fears of rising interest rates have prompted investors to crowd the shorter end of the curve, yields on longer-term corporate bonds have grown attractively plump.
Two, after a period in which credit downgrades outpaced upgrades, Fuss expects the trend to reverse, leading to appreciation in the upgraded bonds.
And three, demand is growing from investors seeking to put idle cash to work in higher-yielding bonds.
This outlook is backed by the underlying belief that the economy is recovering. "We believe the sharp V [the rebound] is coming this year," Fuss says. Indeed, Fuss seems to be finding attractive issues within economically sensitive areas such as the chemical, paper and plastic businesses.
The Treasury/Corporate Portfolio
Mike Martin of Financial Advantage, Inc. in Columbia, Md. (and a Financial Advisor columnist), largely echoes Fuss' fondness for long-term corporates. In fact, one of Martin's favorite funds is Loomis Sayles Bond, run by Fuss and comanager Kathleen Gaffney. Martin likes the multi-sector bond fund's position in BBB corporates, as well as its roughly 8% current yield. "The managers have a terrific record of being able to harvest those yields without getting crushed on the prices," Martin says.
But while Martin likes Fuss' fund, he doesn't quite share the manager's optimism about the economy. Not that Martin is bearish; he believes there'll be a continuing modest economic recovery. But he has about half of his clients' portfolios in Treasury bonds and is avoiding high-yield bonds altogether, "because of my skepticism about the [strength of] the economic recovery." He's also staying away from mortgage-backed bonds, which only outperform in stable interest-rate climates.
Martin is cautious in other ways as well. Like many advisors, he believes that the stock market remains overvalued. Unlike some advisors, though, Martin has the majority of his clients' portfolios in fixed-income-an average 65% fixed-income stake, to be exact. Martin is quick to point out that most of his clients are either in retirement or close to it. Even so, he's clearly more wary of stock-market risk than interest rate risk.
The High-Yield Heavy Portfolio
Let's say you agree with Fuss that the economy is basically on the mend and that corporates will outperform. Nonetheless, you don't share Martin's lack of concern about interest rate risk and thus want to stay away from longer-term debt. After all, a strengthening economy usually means interest rate hikes down the road. Then you'd want to follow the lead of advisors who are hunkering down in high-yield bonds.
Judy Shine of Shine Investment Advisory Services in Englewood, Colo., is staying on the short end of the investment-grade yield curve and is tilting toward junk bonds in her portfolios. She also leavens her portfolios with low-volatility stock funds, such as real-estate funds.
Joel Bruckenstein of Global Financial Advisors in Miramar, Fla., adds convertibles to the high-yield bond mix, along with selected closed-end funds selling at a discount. "My observation is that the next big move in rates will be up," Bruckenstein says, "so I don't see the point in buying high-grade, long-term bonds at the moment."
In short, advisors who adhere to the prevailing macroeconomic view are by no means boxed into a particular fixed-income portfolio. While it's not true that all the portfolios are equal to each other-for one will inevitably perform better or worse-it is true that an advisor can make a plausible case for each.
Olivia Barbee is editor of MorningstarAdvisor.com.