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A common concern I’ve been hearing from investors lately is the fear that bond funds will decline in value when interest rates rise. While this concern is consistent with the basic concept of the relationship between bond values and interest rates, there are other factors advisers and fund managers consider as they build a portfolio.
Some of our members have called to discuss the bond fund exposure we recently recommended for their individual circumstances. They’ve pointed to the losses some bond funds experienced during the fourth quarter of 2010 and to potential interest rate increases.
We know interest rates could go up, and we’re certainly monitoring market conditions. But we have a long-term investing philosophy. At this time, we believe good bond fund managers will be able to handle gradual interest rate increases – if and when they come.
One specific fund our members have called to discuss is the PIMCO Total Return fund, which is offered frequently in employer plans. While the fund is not right for every investor, here are some of the positive elements we’ve seen in recommending it to some of our members. (more…)
Over the past several months we’ve fielded calls from Smart401k clients concerned about investing in bonds. The main reason: interest rates are at historically low levels and seem to have only one way to go – up. While this concept is generally true, the fact is all bonds are not created equal. First, let’s recap the basics so we can move on to how this fits with a retirement plan strategy: when interest rates go down bond prices typically go up – a seemingly good thing for the bond investor. When interest rates go up the price of bonds will fall.
This year has been a rather tumultuous year for investors, with the past month being extremely volatile. The Dow Jones Industrial Average is down more than 35% year-to-date as of Oct. 24. I believe fear has been responsible for a significant portion of the market’s return as investors are overly focused on the health of both our financial system and the economy. I like all of the advisors at Smart401k read and learn as much about the market as we can. One of the things that I have noticed has been the steep selloff in the high yield bond market.
For those of you that are not familiar with high yield bonds (aka junk bonds), they are corporate bonds that have been assigned a credit rating below investment grade by Moody’s or Standard & Poor’s (The two main credit rating agencies). Bonds with a credit rating of BBB or lower from S&P and Baa or lower from Moody’s are considered high-yield bonds. Because of their lower credit rating, these bonds generally pay a higher yield than investment grade bonds. (For more information on bonds click here)
Similar to the stock market, the high yield bond market has been plagued by fear. This fear has resulted in a steep decline, approximately 25% YTD as of Oct. 24th, in the Merrill Lynch High-Yield Master II Index, a common benchmark for the high yield bond market. According to Moody’s, the market has priced in a rise in the default rate to almost 20% which would top the record of 15.4% set during the Great Depression in 1933. The uncertainty in the market has also pushed the yield spread over U.S. Treasuries from around 3% a year ago to over 15%.
A number of bond fund managers, including Dan Fuss from Loomis Sayles, have observed the decline as well and see the current market as an investment opportunity. Mr. Fuss recently gave an interview with Morningstar and said that the current bond market is the best buying opportunity he has seen since 1974.
Please note, I am not advocating or a recommending high yield bonds but rather wanted to write about an observation of recent events. Please feel free to contact us if you have any questions regarding high yield bonds or if you have any questions about your account.
Buck Wendel, Investment Advisor
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