Goodbye Bondshelter, Hello Annuity

After 3 years this experiment is concluded. Beginning sensibly with a laddered portfolio of individual bonds it mutated into embracing volatility by gradually substituting income-focused products. All bonds purchased performed well enough and the strategy return was respectable for the first 2 years. The 3% return for the last year and no prospect for any significant improvement using this financial direction has made this an unattractive proposition. So what happened? Initially the bonds generated reliable returns and were sold for capital gains but as interest rates continued to compress the bonds offered low returns or would have to be predominantly junk category or long-dated maturities. However as yields in bonds diminished so did payouts across the spectrum for income-oriented instruments. This meant that "floating" returns floated downward and so did asset prices. Someday inflation will arise so it may be best to wait though some limited fixed-income portion can still be useful. An annuity is not a substitute for a fixed-income strategy but it has advantages as a complementary tactic. My thanks to the columnists at Forbes magazine for their insights and common sense. All comments welcome.

Penultimate Post: Looking Back With Richard Lehmann

When the current Bondshelter portfolio was converted to a fixed income vehicle in 2009 it began a process of clawing back from a 25% decline. This would require a 33% increase to get back to even. Even with a prospective 2 to 3% gain this year there is still a significant shortfall and to date is still well below this threshold. Additionally the risks in the fixed income space seem to be getting greater as the Fed keeps rates at 0. This blog began with Richard Lehmann's columns and suggestions - most of which have been solid. As he alludes in his last column - the performance can depend on any one day due to the market value of the product. Some recent suggestions like FHY are doing very well. He points out however that the Fed is doing a disservice and there is increasing danger over time.
See his column. The best prospect may be to convert to an annuity given the time and effort and greater sense of unease. The real concern is that the current rally in the markets though real is very possibly on a short leash and can revert suddenly.

What I Learned From VIPSX

The Sunday edition of the San Francisco Chronicle lists the 25 most widely held mutual funds. The Vanguard Inflation-Protected (i.e. TIPS) mutual fund - symbol VIPSX was far and away the best performer of 2011 with around a 14% return. The assets in Bondshelter are held in a Vanguard account and, in fact, this was one of the holdings in 2011. However as a "prudent" measure it was decided to close this out and re-allocate into other areas. The takeaway is that this was probably rash as the economic environment has been best described by Gary Shilling, the economist, and others who predicted not inflation but deflation and a strong dollar. VIPSX performed well as a treasury bond not for its inflation factor. Indeed the ten year treasury (symbol ^TNX) has been hovering under 2% - a historic low. To get back into this Vanguard fund would be "chasing performance". Even Hillary Kramer, a market commentator, has said that investors cannot be willing to accept these abysmally low rates indefinitely. 10 Market Headlines for 2012 Currently the portfolio is on track to finish flat or up 1 to 2%. It is possible for both the bond and stock markets to under-perform in 2012. The question is whether this is worth continuing in light of this too modest return.

Bondshelter Not Bombshelter - Reluctantly Embracing Volatility

Two bonds in the portfolio were subject to the call provision in 2011. The Ford and Verizon bonds were called in. Even with the "make whole" provision the problem is how to redeploy the new cash. Some of this was mentioned in the last post. When the portfolio was first established an 18 month bond with an investment grade ratings could be had yielding 4%. Now Bill Gross in a recent column says that most investors for the next several years will be lucky to get a 5% return. Richard Lehmann has indicated that fixed income investors will need to get used to volatility and eschew the "old normal". His adivice - "Build a portfolio of high-yielding securities for a low-yield environment." His advice some years ago for HHY - the Helios High Yield fund is a good example. Recently another junk bond fund such as FHY looks to be a good candidate to beat that 5% benchmark that Gross references. High yield has been mentioned previously and this article affirms this tactical approach. Junk Bonds Beating U.S. Stocks by 53% Shows No New Recession

Cash Equals Future Opportunities

In any non-deflationary environment holding cash may feel like a losing proposition. Cash also reduces volatility in a portfolio but that too seems like a self-defeating tactic. Currently the Bondshelter portfolio is 10% cash. However cash as an asset allocation has a place. The better way to view holding this is for some set of future opportunities that will present themselves at an unexpected time. For a considered perspective see Is Cash Trash?’ Additionally FFRHX was sold as the rate had floated downward and this return and moderate volatility was deemed insufficient thus adding funds for some future opportunity.

Volatility and the Fixed Income Portfolio

The Bondshelter portfolio is composed of 7 types of bonds which are 65% of the total. There are 13 separate stocks, etf's, or fund-like securities comprising 30% and finally 5% is currently in cash. It would be expected that the volatility of such a composition should be less due to the dividends and interest generated. In fact the portfolio has decreased in value by 5% since market highs in April. Significant but less so than an investment only in equities. In the new world environment of investing principal protection, income, and finally capital gains is the new order. However once the markets settle the real danger may emanate from the bond market. John Waggoner of USA Today has asked How Ugly Can the Bond Market Get?’ The points raised are familiar to those who have turned cautious in this part of the fixed income arena.

Three Tells For The Bond Market

At this time the 10 year U.S. treasury bond is currently yielding under 2%. The rates for these securities are at 60 year lows. Among the reasons cited are the discord in Europe and the flight to safety as well as the stagnant economy. Some have called  the U.S. treasury market the greatest bubble of all time. And bull markets tend to have their greatest run near the end. Recently Kathy A Jones in Schwab Investing Insights suggested quality over yield. Read the Brett Arandt article – ‘Did The Bond Market Just Peak?’ Of late the stock and the bond have both been strong. They can both be weak as well. At some point the bond market top will have manifested.