Sponsored Content – American Century Investments
April 13, 2010
Despite low interest rates, today’s bond market presents a number of opportunities for income-oriented investors.
The current economic and market environment presents intriguing challenges for income seeking, risk-averse investors. One effect of the Federal Reserve’s policy of holding short-term interest rates at historically low levels is to force cautious, safety-oriented investors out of cash equivalent investments. Fed Chairman Ben Bernanke would prefer they put that money to work in the economy or in “risk assets” such as stocks and credit-sensitive bonds. This strategy largely achieved the desired result last year—the economy returned to growth in the third quarter of 2009 for the first time since the second quarter of 2008, while stocks and high-yield bonds staged dramatic rallies in 2009.
In this article, David MacEwen, chief investment officer for fixed income, discusses a number of opportunities that may provide additional yield for clients within a risk-managed, fixed-income framework.
More Fixed Income Information
Click Here
Classic bond benefits of income, diversification remain
It is important to understand that despite the low-interest-rate environment, certain key aspects of fixed-income investing remain constant: bonds are an essential element of your clients’ carefully constructed investment plans, by virtue of their ability to reduce overall portfolio volatility and maximize risk-adjusted returns when held in combination with other higher-volatility asset classes. That is to say, diversification works regardless (some would say precisely because) of the varied performance of financial assets under changing market conditions.
Click Here
From cash to short-term bonds
When discussing yield opportunities, MacEwen says, “For clients concerned about low money market yields, we’ve been recommending higher-yielding, short-duration, high-quality bond funds. These offer significant additional yield over record-low CD and money market rates, but with the comparatively low price volatility characteristic of short-term bonds. Over time, this strategy can provide sufficient yield to essentially negate the risk of additional price volatility.”
Favoring spread products
For those seeking even more income and willing to accept greater price volatility, so-called “spread sector” bonds represent another opportunity. Spread products are defined in relation to Treasury bonds; that is, they trade at a yield difference, or spread, versus Treasuries. Municipals typically offer yields below those of Treasuries because of their advantageous tax treatment, while corporate bonds, mortgage-backed securities (MBS) and government agency bonds offer yields above Treasuries’ to compensate for their additional credit risk. That credit sensitivity can provide rewards, as well as risks. Spread sectors typically outperform Treasuries as the economy improves, as happened in 2009. It is easy to see why this is so. More economic activity means higher revenues and better credit quality for corporate and municipal bond issuers. In addition, it is also true that higher yields can help offset price volatility.
The spread sector attractions for income-seeking investors include: 1) more income than
Treasury bonds (or in the case of most municipal bonds, higher after-tax income); 2) credit quality that improves along with the economy; and 3) ability to avoid price declines, compared with Treasuries, when interest rates rise, as typically happens when the economy is expanding.
One caveat comes with MBS, which tend to be more sensitive to interest-rate changes than other spread sectors because of the exposure of their underlying mortgages to home-loan-refinancing activity. MBS typically do better when rates are relatively steady or change only gradually. In addition, the Fed’s active purchases in the market for government-backed MBS are set to expire early this year. As a result, MacEwen and his team favor non-government agency MBS, which did not receive support from the Federal Reserve and may not be subject to the same degree of reversal. “Among spread products,” says MacEwen, “we currently see the most attractive opportunities in investment-grade corporate debt. But it is important to understand that not all corporate entities benefit equally from economic growth. Careful security selection is likely to be central to generating solid performance going forward. We do not see a continuation of the virtually indiscriminate risk rally that colored 2009 market performance.”
Putting it all together
“The tension many fixed-income investors face is between maximizing current yields and minimizing risk to principal,” says MacEwen. “We think there are a number of attractive opportunities to do that despite the low-rate environment. But we caution advisors and their clients that credit improvement and market performance are not uniform, so careful credit research and security selection are essential. For these reasons, we would recommend a core/ diversified bond strategy that includes high-quality spread sectors to act as a core fixed-income holding. For more conservative investors with a heightened sensitivity to share price changes, a core/diversified bond portfolio focused on short-term securities appears particularly well suited to current market conditions.”
Diversification does not assure a profit or protect against loss in a declining market.
Investment income may be subject to certain state and local taxes and, depending on your tax status, the federal alternative minimum tax (AMT). Capital gains are not exempt from state and federal income tax.
The opinions expressed are those of the investment manager and are no guarantee of the future performance of any American Century portfolio. Statements regarding specific holdings represent personal views and compensation has not been received in connection with such views. This information is not intended to serve as investment advice.
You should consider a fund’s investment objectives, risks, charges and expenses carefully before you invest. The fund’s prospectus, which can be obtained by calling 800-345-6488, contains this and other information about the funds and should be read carefully before investing.
P.O. Box 419385
Kansas City, MO 64141-6385
1-800-345-6488
www.americancentury.com/ipro
American Century Investment Services, Inc., Distributor
©2010 American Century Proprietary Holdings Inc. All rights reserved.
Display article as PDF for printing.
Would you like to send this article to a friend?
Remember, if you have a question or comment, send it to .
