If Federal Reserve policy normally looms large for bond investors, it does so doubly now. The global economy threatens to enter recession, and most central banks are in easing mode. But the Federal Reserve seems unsure of its policy as it delays its first rate hike since the summer of 2006, when it raised the federal funds rate from 5.00% to 5.25%.

The bank wants to elevate rates, but stagnant U.S. household income, slowing growth in China and much of the rest of the world and a wobbly stock market have delayed the process of rate “normalization.”

Through the uncertainty, the Barclays Aggregate U.S. Bond Index is up nearly 1% for the year through late September and up around 2.7% for the one-year period. The Barclays Municipal Bond Index is up around 1.4% for the year through late September and around 3% for the one-year period.

Oxford Financial Waits For Spreads To Widen
Brendan O’Sullivan-Hale of Oxford Financial, with $12 billion under management, isn’t interested in taking credit risk at the moment. The reward for doing so is slim in his opinion, with the Fed having pushed rates down and prices up. As he puts it, “We want fixed income to be boring. We prefer stable, high-credit-quality issues, and we’re not willing to take a lot of credit risk unless we’re receiving a lot of compensation.”

At the moment, Oxford’s portfolios are invested in very high-grade intermediate maturity bonds, municipal or taxable. O’Sullivan-Hale says the firm has been in and out of high yield and currency trades at various points over the past decade, but doesn’t find opportunity in those areas currently.

He ventures the idea that emerging market bonds might get interesting again, but that the yields are still not adequate to justify a meaningful allocation to them. It’s possible that Brazil’s and Russia’s spreads could blow out at some point as those countries feel the strain of the dramatic price decline in oil, but it hasn’t happened yet. In the late 1990s, for example, when Russia went through a financial crisis, spreads widened to a range of 600 to 800 basis points over Treasurys. Until something similar happens, Oxford will most likely be a bystander in emerging markets.

Nor are high-quality corporate bonds particularly attractive, says O’Sullivan-Hale. Instead, Oxford has chosen managers for their access to more exotic instruments such as credit card debt (in modest quantities).

Additionally, Oxford’s portfolios are in the four-year duration range, a bit shorter than the Barclays Capital U.S. Aggregate Index. There’s a risk that rates could spike, albeit not an imminent one, O’Sullivan-Hale avers.

Oxford has a wide range of clients in the $10 million to $50 million range, and O’Sullivan-Hale and his colleagues have counseled them to be patient in taking risk and reaching for yield at the moment.

Cumberland Relies On In-House Municipal Research
According to the outspoken David Kotok of Cumberland Advisors, “The biggest issue confronting investors is the Fed. The game of expectations dominates the conversation. And that’s a terrible situation in my opinion. What the Fed has done for over two years, starting with the taper tantrums, is send a sequence of mixed messages. They have introduced an uncertainty premium into financial markets. It’s hard to point to a metric that shows that—yield curve, etc.—but there is an uncertainty premium. It’s there. You see it in volatile, surprise-element, bond market gyrations.

“If they continue to raise uncertainty premiums, you get slower growth than you would normally get. The Fed isn’t helping [the] economy in this way. [When you] add to that [the] external influence of negative interest rates in Europe and flat interest rates in Japan, and we have a situation unlike anything I’ve seen in my 50-year career.”

Kotok, who shepherds $2.5 billion, sees little value in Treasurys and corporates despite some spread widening between the two over the past few months. Instead, he prefers the municipal bond market for both its relative credit safety and extra yield.