This month’s scenario: Clients are a retired couple in their early 70s, who have relied on interest income to supplement their pensions and Social Security. Their income has fallen significantly as their certificates of deposit matured at much lower rates and they’re considering income-oriented mutual funds for $100,000 of their $500,000 total savings.
What research tools do you use to identify prospective funds for clients?
I use Morningstar to provide apples-to-apples quantitative research data on mutual funds. I use extensive reading and seminars to create my economic forecast which I use to tailor my clients’ portfolios, including the balance of their income funds.
What specific fund categories would you recommend for the scenario-clients’ consideration and why?
I would place 70 percent of the portfolio in high-quality bond funds, with a preference for short-term bonds, to provide some protection against rising interest rates.
When rates reach a more normal level, I would likely cut the short-term level to 20 percent and boost the long-term to 50 percent or more.
I use a multi-sector bond fund to capture opportunities in the bond fund universe that are too specialized for me to see, in both foreign high quality, foreign junk, and U.S. junk bonds.
I typically allocate 20 percent to multi-sector, however, at times I will redirect a portion of this to an area that I wish to emphasize (which is the reason for the 5 percent directed to high yield bond fund). I began this emphasis in late 2008, as high-yield bonds began to demonstrate an unreasonably high yield, relative to Treasurys and high-quality corporates.
I expect to eliminate this as the recovery matures. Just this year I have introduced bank loan funds and directed 10 percent from high quality (which typically I set at 80 percent of bond money) to this area.
This is to be used only during an economic recovery, which typically accompanies a rise in interest rates and an improving environment for companies which use these loans. I used them in the prior recovery and then stopped using them as the economy had recovered, and plan to do the same in this cycle.
I feel that this approach balances conflicting priorities, stable income and stable portfolio value while balancing opportunities and risks, given the uncertainty of rising rates, inflation versus deflation, economic recovery versus double-dip, etc.
What specific funds and allocations would you recommend within those categories?
I would make the following investments:
$40,000 Lord Abbett Limited Duration (LLDYX), short-term corporate bond fund
$30,000 PIMCO Total Return (PTTRX), intermediate-term corporate bond fund
$15,000 Eaton Vance Strategic Income (ETSIX), multi-sector bond fund
$10,000 Oppenheimer Senior Floating Rate (OOSAX), bank-loan fund, known previously by ticker XOSAX
$5,000 Artio Global High Income (BJBHX), high yield bond fund
I don’t recommend closed-end funds at this time, due to concern that the client may wish to take a withdrawal, or I may wish to strategically reduce/eliminate a piece of the portfolio, at a time when the discount remains wide.
This portfolio has a duration of 2.44, which should serve to limit losses when interest rates rise from their very low current levels. It has an average net expense ratio of 0.72 percent with a worst historical one-year return of -6.7 percent.
I consider this worse than a worse-case situation, for this portfolio is not intended as an all-weather one. The 10-year average return was about 6.5 percent annually with an estimated 12-month trailing portfolio yield for of 4.89 percent.