Moderately Defensive
Atlanta-based Brightworth, a fee-only wealth management firm, currently has about one-fourth of its approximately $1.1 billion in assets under management allocated to fixed income. “We’re a little underweight to fixed income right now because of current low yields,” says Don Wilson, Brightworth’s chief investment officer.

Brightworth’s base-case scenario for the next several years—the one it thinks is most likely—is continued slow economic growth with some rise in interest rates, though nothing dramatic.

Still, one can’t rule out the possibility, Wilson says, of faster-than-expected economic growth (which could push up rates) or an exogenous shock—such as deteriorating conditions in China and Europe or escalating conflicts in the Middle East that affect oil prices. If a shock were to push the U.S. economy into a recession, Brightworth would expect interest rates to come down from current levels.

As for its investment strategy, “We’re a little defensive in our portfolios,” says Wilson, “but we don’t want to be so defensive that if we do stay in this low-yield environment we miss out.”

Brightworth’s fixed-income portfolio is divided into three buckets: core U.S. bonds (representing approximately 35% of assets), a flexible allocation to more unconstrained bond managers (35%) and a satellite piece (30%) that includes high yield, TIPS and international and emerging markets debt. The global portion provides some diversification protection against U.S. interest rate risk, he says.

Brightworth is allocating more to flexible bond managers than it has historically because the firm thinks rising rates could hinder intermediate core bond funds. One product it uses is the J.P. Morgan Strategic Income Opportunities Fund (ticker: JSOSX). “They’re trying to make money without just getting a tailwind from duration and falling interest rates,” says Wilson, who notes the fund goes long and short in different sectors and often holds significant amounts of cash.

In its core bond strategy, Brightworth uses the Vanguard Intermediate-Term Tax-Exempt Fund (VWITX), a low-cost municipal bond fund, and for clients with tax-free accounts, the firm uses the Dodge & Cox Income Fund (DODIX). It also uses other products in its core bond strategy.

The firm works with approximately 450 clients—primarily high-net-worth individuals and families. Each client’s allocation to fixed income is based on his or her goals and objectives, time horizons and risk tolerance. The firm’s middle-of-the-strategy portfolio is 50% in stocks, about a third in alternative managers and about 17% in bonds. Brightworth has increased its use of alternatives as stock prices and valuations have risen and as the return expectations for both stocks and bonds have fallen, Wilson says.

The firm tries to keep the next five to six years’ worth of anticipated withdrawals in fixed income and cash so clients won’t have to touch or sell their stocks in a downturn, he adds.

“I haven’t heard of any clients who aren’t able to sleep at night because of their fixed income,” he says, “but this is not the time to be reaching for yield.”

Mad for Munis
Cumberland Advisors, an RIA managing $2.25 billion in separate accounts for high-net-worth investors plus additional assets in institutional accounts, is using federally guaranteed U.S. debt in “a very sparing and limited way,” says David Kotok, the firm’s co-founder, chairman and chief investment officer.

Cumberland, which is headquartered in Sarasota, Fla., and has a second office in Vineland, N.J., is inclined not to own intermediate and longer-term Treasurys since they currently have low yields and could suffer a decline in value amid somewhat higher interest rates. “I wouldn’t lend my money to the government of the United States at that interest rate,” he says, “so I certainly wouldn’t do it for my clients.”

The firm is using short-term Treasurys strictly as a parking place for cash alternatives, says Kotok, noting that it’s very likely cash will pay zero for the next six months. He currently favors three-year Treasurys for their yield advantage over two-year Treasurys.

The firm holds some high-grade corporate debt but is not emphasizing it because the spreads between corporate credits and Treasury credits remain very narrow. Cumberland doesn’t own junk bonds. Their recent widening spread over corporate bonds could, as history has shown, be a warning sign for stock market investors, says Kotok.

Where Cumberland is aggressive, he says, is in taxable and tax-free municipal bonds. They are cheap relative to Treasurys. The firm especially likes essential service revenue bonds—those that have a senior pledge off a revenue stream of a necessary utility or service. These include the bonds of sewer companies, airports and water utilities.

Cumberland holds a big position in taxable and tax-free bonds issued by the New Jersey Turnpike Authority. Kotok says these bonds offer attractive yields. “The New Jersey Turnpike is one of the strongest toll road credits in the U.S.,” he says. “What are you going to do if the toll goes up two bucks?” he says. “Get mad and take some other way [from Wilmington, Delaware] to New York?”

Utah also offers very solid high-grade credit and attractive yields, he says. The state’s public debt structure doesn’t allow issuance of new debt until old debt is paid off, its unemployment rate is very low, its economy is growing, its budgets are balanced and its funding levels for promised post-retirement benefits and other benefits and obligations are very strongly backed, he says.

Cumberland has five people devoted to researching Puerto Rico, whose credit has been downgraded to junk status. It owns some of the territory’s insured bonds but won’t touch uninsured ones. “Puerto Rico is not a place for the uninformed investor to go,” cautions Kotok.

The firm holds little non-U.S. fixed income because the yields are lower and the risk is higher overseas. And the firm thinks the dollar will strengthen as the Fed adopts a neutral monetary policy and gradually tightens rates and as the economy grows modestly.

Kotok says fixed income was a constant topic of conversation in July at Camp Kotok, his annual Maine fishing trip for asset managers and economists. “We had 58 people, which means you get 58 opinions,” he says. However, “There was agreement that circumstances are changing and that that’s global, not just in the U.S.”

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