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Portfolio > Mutual Funds > Bond Funds

When Is Risky Investing Safe and Safe Investing Risky? Now.

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Financial advisors looking to boost returns and reduce investment risks for clients got some interesting recommendations on the first day of Envestnet’s 2015 Advisor Summit in Chicago.

At the morning market outlook panel, Zachary Karabell, head of global strategy at Envestnet, said there was “more risk in safety” and “more safety in risk,” contrary to conventional wisdom. He later explained that supposedly safe investments like utility stocks and government bonds in developed markets pose more risk for investors than high-yield bonds or emerging market equities.

The Utilities Select Sector SPDR (XLU) is down 11% from its late January high, and 30-year German government bonds, known as “bunds,” lost 12% of their value over the past two weeks, according to Bloomberg, supporting Bill Gross’ description of them as “the short of a lifetime.” Unfortunately Gross suggested investors wait until the ECB ends its quantitative easing bond buying program before shorting the bund, missing the boat if he followed that advice.

“One of the biggest unseen risks is how quickly you can lose money in the bond market,” said Larry Adam, chief investment strategist at Deutsche Asset Management.

That depends, of course, on which bond market and which bonds. Heidi Richardson, global investment strategist at BlackRock, noted that even investment-grade corporate bonds issued by Nestle (VX), the Swiss chocolate company, have a negative yield now, as do government bonds in Switzerland, Germany, Denmark and some other European countries. Investors in these bonds are actually paying their issuers to own them, rather than the reverse, and when their yields eventually turn positive those same investments will be worth less.

Richardson sees opportunities in U.S. large tech stocks and foreign equity markets including China, Japan and emerging markets. She also sees more risk in the U.K. leaving the European Union than Greece leaving the eurozone.

In an afternoon breakout investing session on bonds, several fund managers discussed the opportunities rather than risks in various fixed income sectors.

Tim Paulson, client portfolio manager at Lord Abbett, where bonds account for almost 70% of actively managed assets, said the risk premium for investment grade and high-yield bonds “more than compensate for the risk” in the market now. He explained that the break-even yields to compensate for potential defaults versus risk-free Treasuries are at spreads several times wider than usual. In addition, said Paulson, corporate balance sheets are in good shape, debt-to-earnings ratios are low and most new corporate issues are being used to reduce debt, not for leveraged buyouts or major capital expenditures. “The fundamentals justify the spreads.”

Dan Close, a portfolio manager at Nuveen, which manages more than $100 billion in municipal bonds, spoke of the muni market’s low default rate, shrinking supply and increased tax-equivalent returns as more states raise taxes. (Interest paid on municipal bonds is usually exempt from state, local and federal taxes, which increases the tax-adjusted yield.) 

A California resident earning over $1 million who owns a California muni bond with a 5% yield, for example, would earn a tax-adjusted yield of 7.65%, after accounting for a 13.3% top marginal state income tax and 39.6% top federal tax rate.

Yan Zilbering, investment analyst Vanguard, recommended foreign bonds to offset some of the risks of equities and diversify the risks of a U.S. fixed income portfolio. He explained that U.S. bonds are “imperfectly correlated” with foreign bonds and U.S. investors are underweight foreign bonds compared to their global market share. But he noted the need to hedge the currency exposure because when the value of the dollar rises the value of foreign bonds usually fall.

In the global bond market, however, U.S. and foreign bonds have both been losing value as global yields rise, though not always at the same rate. That pattern continued Wednesday following statements from Federal Reserve Board Chair Janet Yellen that unnerved bond and equity markets. In an interview with IMF Managing Director Christine Lagarde, Yellen said long-term rates “could see a sharp jump” when the Fed begins to raise rates and stock market valuations appear “quite high” posing “potential dangers.”

Karabell said central bankers in general are not “the best guides” for a stock valuation analysis. Adam of Deutsche Asset Management, however, said, “Yellen is acknowledging there are a lot more risks out there.”

– Check out more coverage of the Envestnet Advisor Summit on ThinkAdvisor.


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