Cash isn’t trash for many fixed-income investors these days.
That was the analysis of a group of bond managers who held a press briefing in Manhattan on Thursday.
Indeed, they said this is a time to pick through the bond market carefully. Sometimes it makes sense to hold higher cash balances, waiting for better investments. That’s because of potential bond investment problems, including few choices, potential liquidity woes and expected interest rate rises.
For instance, low interest rates mean the municipal bond market relative to inflation is highly overvalued, they said. That also means investors are facing significant duration risk, according to officials of Santa Fe, N.M.-based Thornburg Investment Management.
“Are investors getting paid to take risk right now? I would say they are not,” said Christopher Ryon, managing director and co-portfolio manager of Thornburg’s municipal bond portfolios.
General obligation bonds are paying about 2 percent today while inflation is about 1.5 percent, Ryon noted.
“So you have a real rate of 50 basis points. The long-term average for real rates, on 10-year Triple-A municipals going back to 1994, is 205 basis points,” Ryon said. The five-year numbers are also bad, he added.
Ryon says he can’t find much value in the municipal bond market, so he is keeping 10 percent to 15 percent of his portfolio in cash. Normally, these bonds funds have a cash component in the low to mid-single digits, Thornburg officials said.
How about reaching for better returns by taking greater risk?
High-yield municipal bonds can provide bigger returns, but the investor is taking huge risks because the investment category is narrow, they said.
Some fixed investors have become obsessed about when the Fed will raise rates. They are seeking protection from when the central bank finally does. So they are using low and negative duration strategies, noted Jeff Klingelhofer, portfolio manager of the Thornburg Limited Term U.S. Government Fund.
These strategies, he said, aren’t bad, but “investors often don’t understand their risks. You never get anything for free.”
The risk of rising can hurt those using duration strategies, he said.
“We actually did a study on them and found that these strategies actually underperformed in both rising and falling rate environments,” said Klingelhofer.
The riskiness in the fixed-income market is shown by the actions of banks, added Lon Erickson, portfolio manager for Thornburg’s Limited Term Income Fund.
“Banks have become less dealers in the traditional sense, buying bonds and selling them down the line, and are acting more like brokers,” he said.
That poses risks because, in times of troubles, banks won’t be players in the fixed-income market and that could lead to liquidity problems, Erickson noted.
What happens in the next crisis for bond fund families if banks can’t provide liquidity, he asked.
Erickson said “we are holding more cash these days.”
What does Thornburg tend to own in bad times for the bond markets? Those bonds with deep markets.
“Treasuries and agency bonds and bonds that we can turn into cash quickly,” Erickson said. “There’s not a lot of compensation in them. But we are holding them for potential liquidity purposes.”
Thornburg has some $64 billion in assets under management in seven equity and 11 bond funds, as well as some separate account, institutional business and Undertakings for Collective Investments in Transferable Securities (UCITS).