Gone are the days when you could dump your savings in Treasurys and forget about them. Today it’s about strategy and return. Advisers are calling corporate bonds “the new stocks,” pointing to their 6 percent annual yields as comparable with what stocks will likely return in the next few years. “What can be bad about that?” asks Bruce Berkowitz, manager of the Fairholme fund, which holds both stocks and bonds. “It’s the same or better return for less risk,” he adds, since bondholders get paid out first if the company runs into trouble.
Bonds at both ends of the spectrum have energized investors. The double-digit yields on high-yield bonds – loans to struggling firms are known as “junk” for a reason – have spurred investors to pour $17.5 billion into junk bond funds in the first half of this year, compared with just $1.6 billion for all of 2008, according to fund tracker Morningstar.
Even Treasurys, generally considered the least exciting of all investments, have seen a crazy run-up in the wake of the crash, rising an abnormally high 34 percent last year, several times greater than the gains logged in recent years. There’s a reason for all this activity, says Berkowitz: With bond returns now likely to do better than stocks, investors can use them to play offense, not just defense.
Of course, while bonds may be more lucrative than they used to be, they’re also less reliably safe. The biggest threat bond investors face is inflation. A growing number of experts are worried that unprecedented government spending – namely, the bailout money and stimulus packages – could drive interest rates upward. That will be particularly painful for investors who rely on the steady income from bonds, since that income doesn’t usually rise as other prices do.
By far the most popular protection against inflation is Treasury Inflation-Protected Securities. These bonds are linked to the consumer price index – a gauge for whether the economy is heating up. With the economy in the deep freeze recently, investors have shied away from TIPS, but experts say inflation is on the horizon and now may be the time to get in.
Junk bonds may be riskier, but their yields almost always stay ahead of inflation, says Robert Arnott, founder of investment-management firm Research Affiliates. Higher-quality corporate bonds are even safer: Outside the financial, automotive and real estate sectors, corporate balance sheets are in good shape, says Mike Weldon, who oversees adviser and investor education at Lord Abbett. As with stocks, many planners advise investors to look abroad, recommending funds with a mix of foreign government and corporate debt, like the T. Rowe Price International Bond fund, Pimco’s Emerging Market Bond fund or Barclays’ Capital International Treasury bond ETF.
The crash reminded investors that they can lose their principal in a bond fund, just as they could on any individual bond that’s sold before its maturity date (when the debt comes due and the bondholder has the initial investment returned). Since rates on short-term bonds are meager at best, and inflation isn’t here yet, Charles Farrell of NorthStar Investment Advisors recommends that clients with a sizable allocation to fixed income buy bonds individually and hold them to maturity to shield themselves from fluctuations in prices.
He adds that investors relying on their bond portfolio for income would do well to ladder their bonds – staggering the investments so a portion of the bond portfolio matures every year. For investors sticking with funds, a similar effect can be had by dividing their bond portfolio between a short-term and an intermediate-term fund, with a small portion in TIPS.
Source: 2009 The New York Times Syndicate