Interest rates may remain subdued for longer than expected, despite the Federal Reserve ending its quantitative easing program as U.S. economic growth is sluggish, said investment managers on Wednesday.

Gross domestic product is unlikely to rise above 2 percent growth, said Jeff Sherman, portfolio manager, commodities, at DoubleLine Capital, noting that the housing market remains sluggish and government spending is falling. Recent corporate earnings news was also mediocre, he said, and by the end of the year the 10-year U.S. Treasury note yield will likely hold at current levels, which is just around 2.5 percent.

Sherman spoke Tuesday at the HighTower Apex 2014 conference in Chicago as part of a three-person panel on the outlook for fixed-income investing.

That view runs counter to the expectation that interest rates were going to rise because the Fed was ending its bond-buying program and that financial advisors need to move out of longer duration bonds and stick to fixed-income investments like bank loans, floating-rate instruments and shorter-duration vehicles. But that hasn’t worked out so far this year.

As a result, Sherman said, financial advisors shouldn’t automatically shun longer-duration bonds. And for financial advisors who need to stick to high-quality debt instruments, U.S. Treasuries have a higher yield than other similarly rated debt, like German bunds, Sherman said.

He said if he had to invest new money he would take a barbell approach, with one side of the barbell having longer-term bonds to offer the safety and diversification for a portfolio, with shorter-term notes and floating-rate instruments as the other barbell. He finds the worries about being long duration out of place, considering some advisors “are gladly buying private equity.”

What he wouldn’t do is buy in the “belly” of the yield curve, or bonds with medium-term duration, as those will be hit the hardest if inflation rises.

He also said even if interest rates rise 100 basis points and it’s done in a measured way, “Who cares? You reinvest along the way. It’s the sharp rises that hurt. So know your risk.”

John Miller, managing director, co-head of fixed income at Nuveen Asset Management, said municipal bonds are worth a look as some states’ and cities’ finances are improving, but financial advisors still need to exercise caution. Miller said concerns about defaults are overblown, even as investors point to Detroit’s bankruptcy. He said most of the $18 billion in Detroit’s obligations are for health care and pensions, while a much smaller part of that total are general obligation bonds.

He also noted that payouts on defaults are rising, with up to 85 cents on the $1 recovered.

While investors are focusing on duration risk, Mark Okada, cofounder and chief investment officer of Highland Capital Management, and Sherman said they are more concerned about credit risk and liquidity risk in the bond markets.

Credit risk is a much more pressing worry than duration risk, Okada said, especially with the amount of new corporate debt being issued. That means valuations matter, Sherman said.
Also, liquidity risk is an issue. Tighter liquidity is an unintended consequence of the Volker Rule and Basel III requirements, Okada and Sherman said. Banks need to own high-quality investments, which usually mean Treasuries. However, the Fed owns about 60 percent of Treasuries, “so less than half of the bond market can be traded. If liquidity dries up, it could cause a credit event,” Sherman said.