With yields low and interest rates headed up, what kind of bonds do advisers buy? ​

Because they offer diversification, multisector bond funds might be a good bet

Sep 19, 2017 @ 12:39 pm

By John Waggoner

The ancient Etruscans believed you could tell the future by examining sheep livers, a practice called haruspicy. This was known as the wisdom of the ancients. Nevertheless, haruspicy probably had a better record of predicting interest rates than many modern methods, which remain tenuous, at best.

A June survey of members of National Association of Business Economists showed the average prediction for the yield on the 10-year Treasury note at year-end to be 2.75%. It's 2.17% now.

A remarkable amount of money is riding on those predictions. In a little more than a year and a half, investors have poured an estimated net $487 billion into bond funds and ETFs, which now have more than $4 trillion in assets. Much of those flows have been directed there by advisers, few of whom rely on reading entrails, but many of whom rely on guidance from Wall Street economists. The question now: Given the uncertain outlook, how best to deploy a client's assets?

The answer: Carefully. Just as value-oriented equity managers are at a loss for finding stock bargains, bond managers don't see much value in most investment-grade bonds. And overhanging the entire bond market is the threat of higher interest rates.

When a $10,000 investment in 10-year Treasury notes returns just $217 a year in interest before taxes, investors have very little cushion from price declines. In the past 10 years, the 10-year T-note yield has ranged between 4.67% after the Lehman Brothers collapse in 2007 to a low of 1.38% in July 2016.

"We think it's likely to stay in the lower end of that range for the foreseeable future," said Peter Palfrey, co-portfolio manager of the Loomis Sayles Core Plus Bond Fund (NEFRX). "We're continually surprised by the resilience of the Treasury market."

Palfrey does expect rates to drift upwards, thanks to a relatively strong economy and the Federal Reserve Board's decision to sell off some of the holdings it accumulated during its quantitative easing programs. Barring some large and unexpectable event, however, he doesn't expect an interest rate spike.

Even gradual increases in rates, however, means gradual erosion in Treasury prices. In the 1970s, when rising inflation triggered rising interest rates and negative real returns from bonds, traders dubbed Treasuries "certificates of confiscation." While the next few years may not produce 1970s-style inflation, even a gradual rise of interest rates to 3% or more over the next five years could mean negligible returns for Treasuries at best.

None of this has been lost on the bond market, and many investors have moved from Treasuries, which have no credit risk, to investment-grade corporate bonds, which do. But top-flight credits such as Apple, which has greater cash reserves than many small countries, don't yield much more than Treasuries. The average A-rated corporate bond yields about 1.15 percentage points more than comparable Treasuries, according to John Lonski, managing director and chief economist at Moody's Capital Markets Research Group. Like Treasuries, thin yields on investment-grade bonds leaves relatively little room for error. The last time credit spreads were so thin was in 2007, "Just before things began to unravel," Mr. Lonski said.

One area that looks slightly less overvalued, peculiarly, is high-yield bonds, currently trading at about 3.9 percentage points over Treasuries. "We continue to like riskier assets," said Joseph Portera, chief investment officerof high yield and mulit-sector credit with Invesco Fixed Income. "In our multisector bond fund, we're underweight investment grade and overweight high yield. We troll for alpha in the BBB space."

What's an adviser to do? To reduce interest-rate risk, adjustable-rate bond funds, particularly bank loan funds, are one solution. Guggenheim Floating Rate Strategies (GIFIX) currently yields 3.93%: It's up an average 4.86% a year and the institutional shares charge 0.78% a year. In the ETF space, there's SPDR® Blackstone/ GSO Senior Loan ETF (SRLN), currently yielding 3.89%. It's up an average 2.56% the past three years. Expense ratio: 0.70%.

Given the market's overall uncertainty, a selection of multisector bond funds might be your best bet: You'll get an extremely diversified portfolio that, at least in theory, should help protect your downside. (I say in theory because the last protracted bond bear market ended in 1981, when anything but the most basic bond offering was just a twinkle in the fund industry's eye.) Three to consider:

• PIMCO Income (PIMIX), up 7.12% this year, and yielding 5.36%. Expense ratio: 0.45%.

• Invesco Multi-Asset Income Fund (PIFYX), up 9.29% this year and yielding 4.69%. Expense ratio: 0.79%.

• Loomis Sayles Strategic Income (NEFZX), up 7.58% this year and yielding 2.84%. Expense ratio: 0.96%.

Short of building your own bond ladder — the topic for a later column — multisector bond funds probably hold out your best chance of giving clients exposure to a globally diversified bond portfolio. Investing in more than one makes sense, too: What one manager feels in his liver might not be what actually comes to pass.


What do you think?

View comments

Recommended for you

Upcoming Event

Nov 13


Best Practices Workshop

For the sixth year, InvestmentNews will host the Best Practices Workshop & Awards, bringing together the industry’s top-performing and most influential firms in one room for a full-day. This exclusive workshop and awards program for the... Learn more

Featured video


The bizarro world of DOL and SEC rule supporters

Managing editor Christina Nelson talks with senior reporter Mark Schoeff Jr. about why groups that supported the Labor Department's fiduciary rule oppose much of the SEC advice package, and vice versa.

Latest news & opinion

9 best - new - financial adviser jokes

Scroll through for nine new financial adviser laughs.

Captrust, prominent 401(k) advice firm, ramps up its wealth management business

Captrust wants to grow annual revenue from wealth management to 50% from 30% over the next five years.

Fidelity CEO says zero-fee funds aimed at expanding its universe

Johnson says way to prosper in financial services is 'by building relationships.'

SEC advice rule contains a huge hole

Jay Clayton aims to clear up investor confusion by drawing a distinction between brokers and advisers in the agency's proposed package of revised standards. But where do dual registrants fit?

9 signs it's time to fire your client

Here are signals that a client should be asked to leave, according to experienced financial advisers.


Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting investmentnews.com? It'll help us continue to serve you.

Yes, show me how to whitelist investmentnews.com

Ad blocker detected. Please whitelist us or give premium a try.


Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print