Bond Market Math (Conclusion)

So how do we put it all together?

Bond investors need to understand broad trends in the economy and the markets in order to invest profitably. It’s clear that the economy continues to expand, in spite of the drama we’re seeing in Washington. Interest rates are moving higher. Corporate balance sheets are healthy, and companies are expanding in emerging economies.

So the right way to invest in bonds is to own bonds that either mature or reprice sooner than the benchmark; that have exposure to corporate expansion, and that have embedded options that will expire worthless. Taking modest credit risk in a portfolio is a sound strategy—but a limited one. The spreads of the most stable global corporations are quite narrow. For example, 5-year Coca Cola bonds only pay about 0.30% over Treasuries. Still, investing can be a game of inches.

Floating-rate debt can keep a portfolio’s duration short. But be careful! Longer rates have gone up, but short-term rates may be anchored for a while. Mortgages have embedded options, because homeowners can refinance whenever they wish—but don’t when rates go up. Structured Mortgage-Backed Securities pay high current coupons, although we don’t know what Congress may do to reform Fannie and Freddie. The mortgage giants are the gifts that keep on taking—and taking, and taking.

Finally, good old callable bonds—issued by Agencies and Corporations—are less likely to be called now than they have ever been. When rates rise, those calls become useless to the issuer.

Keeping a portfolio short; taking prudent credit risk; writing value-free options—combining these strategies should give bond buyers the income they need to outpace gradually rising rates. The Fed has said that it wants higher inflation, and the Fed eventually gets what it wants. Long-term investors should be prepared.

Douglas R. Tengdin, CFA

Chief Investment Officer

By |2013-10-09T10:05:51+00:00October 9th, 2013|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

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