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As investors begin to prepare their portfolios for the threat of rising rates, one economist is warning that Non-Traditional funds, which are designed to go “negative duration” (shorting bonds) to capture positive returns in a rising interest rate environment, are not the answer.
To see a list of high yielding CDs go here.
While these funds may seem like a good idea on the surface, Vanguard’s Chief Economist, Joseph H. Davis, Ph.D., believes investing in these funds with the purpose of capturing positive returns in a rising interest rate environment is a futile exercise.
The problem is accurately predicting the direction of rates with any level of consistency. “Market-timing has been proven time and again to be a losing strategy for most investors. The typical investor ’s return lags the return of the mutual fund in which they are invested for this reason. Interest rates are notoriously difficult to forecast accurately over short time horizons, making the duration-timing argument not very compelling.” Davis said in an interview. Importantly, the payoff to taking interest rate risk has historically been positive over the long-run. So any “negative duration” investment would generally run counter to the goals of most long-term investors. And even over short- to medium-term time horizons, with an upward-sloping yield curve there is a fairly high hurdle in foregone yield that investors need to make up in market-timing decisions. “An important part of bond investing is knowing why you own the asset in the first place.” Says Davis, “Arguably, bond investing is never really about generating the highest return possible over the long-run. There are asset classes, such as equities, that are better positioned to accomplish this.” Bonds make sense because they provide a “buffer,” or a diversification benefit, when paired with riskier asset classes. In this regard, an inverse bond investment provides a performance profile that will tend to move with riskier assets, actually doubling up on risk rather than helping to mitigate it. You can read the full interview with Joseph H. Davis, Ph.D here.
Todays Other Top Stories
LearnBonds: – DuPont – A venerable giant in transition. – DuPont hasn’t missed a dividend payment for a single quarter over the last 110 years. But does that mean you should buy it?
Indexology: – Late July muni minutes. – Long-term bonds have posted solid gains thus far in 2014, with rates holding low longer than most expected. The composition of the municipal bond market is heavily weighted with short duration bonds. The looming sentiment of rising rates and inflation has investors focused on reinvestment risk; however, a supply imbalance systemic of voters’ hindrance for governments to take on additional debt has municipals as a whole outperforming their peers.
Businessweek: – Record rally revived with least issuance since 2001: Muni Credit. – The rally in the $3.7 trillion municipal market is picking up momentum, extending an unprecedented streak of gains as issuance sputters to the slowest pace in 13 years.
Bloomberg: – Puerto Rico debt load defied as bonds extend rally. – The Federal Reserve Bank of New York says Puerto Rico needs to cut its debt to levels from 2000. The burden isn’t stopping buyers of distressed assets from driving the island’s obligations to their longest rally since May.
Reuters: – Municipal issuance tumbled in July. – Issuance of U.S. municipal bonds fell steeply in July, with sales for the first seven months of 2014 running 15.4 percent below the same period last year, according to Thomson Reuters data released on Friday.
Bloomberg: – Puerto Rico funds may fall to $212 million in 2015, Moody’s says. – Puerto Rico’s Government Development Bank may all but drain its available funds by March 31 if revenue collections trail projections, Moody’s Investors Service said.
About.com: – How to choose the best funds for a 401(k) plan. – Choosing the best mutual funds in a 401(k) plan can be a challenge, to say the least. Most 401(k) plans do not provide investment advice along with the mutual funds choices. Given the fact that investing and retirement concepts are not commonly taught in schools, means that the average 401(k) participant is a do-it-yourself investor.
Investment Week: – Can this trio of ‘yield dampeners’ protect bonds from rate rise? – Investors predicting historically-low interest rates will rise after the end of quantitative easing are misguided, M&G’s fixed income desk have said.
WSJ: – Bears who won big during finance crisis are growling again. – Many of the Wall Street money managers who made billions by anticipating the U.S. housing bubble see more trouble on the horizon. Unlike before the crisis, when those traders were mostly united against subprime mortgages, the wagers vary this time. Some are against U.S. junk bonds, while others are targeting European sovereign debt.
Charles Schwab: – Is now the time to invest in Treasury inflation-protected securities? – Now that inflation is hitting the Federal Reserve’s target level of 2%, should investors be adding Treasury Inflation-Protected Securities (TIPS) to their portfolios? The recent rise in inflation gives us a more favorable view on the valuation of TIPS.
Sober Look: – Expect higher treasury yields in second half. – While many investors refuse to accept this fact, we are clearly marching toward higher treasury yields later in the year and in 2015. Even after today’s bond selloff, we are still around the yield levels we had during the dark days of the government shutdown. Here are a couple of key factors that will drive yields higher from here.
Investment Grade Bonds
Zacks: – 5 Best performing investment grade bond mutual funds in 2014. – The 5 best-performing year-to-date investment grade bonds that also sport a Zacks Mutual Fund Rank #1 (Strong Buy). Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but the likely future success of the fund.
High Yield Bonds
Reuters: – Third straight week of outflows from high-yield funds. – US high-yield funds have seen a third consecutive week of outflows, Lipper reported on Thursday, with US$1.476bn being pulled out of the asset class.
Reuters: – High-yield investors welcome volatility. – High-yield bankers will unleash a barrage of deals over the next two weeks, even though big outflows and rate rise fears have put the asset class in its most volatile state in months.
AdvisorShares: – Expanding the opportunity set for income generation. – High yield investors should understand the difference between an index-based product and the expanded opportunities available to active managers.
MoneyWeek: – Air escapes from the junk-bond bubble. – In the easy-money era of the past few years, one of the most eye-catching bull runs has taken place in the highest-risk part of the corporate bond market, known as junk bonds.
WSJ: – Junk bonds sink on fears rally will end as economy picks up. – Investors retreated from risky corporate debt on Thursday, sending prices tumbling and deepening fears of an end to a long rally in junk bonds.
Reuters: – High-yield bond funds worldwide post $4.4 bln outflows -BofA. – Investors worldwide pulled $4.4 billion out of high-yield junk bond funds in the week ended July 30, marking a third straight week of big withdrawals from the funds, data from a Bank of America Merrill Lynch Global Research report showed on Friday.
FT: – Russian assets look cheap, but could get cheaper. – If financial markets are anything to go by, the toughest economic sanctions against Russia since the end of the Cold War have been a damp squib.
FT Adviser: – Emerging EM nerves as U.S. growth brightens. – Emerging markets are heading for their worst week in over four months, as rising optimism over US economic growth has re-sparked speculation on when the US Federal Reserve will raise interest rates, FastFT reports.
Financial Chronicle: – Look beyond debt mutual funds, your options are plenty. – The recent changes in tax provisions on debt mutual funds brought to fore the various fixed income options available for investors in the market. It is also pertinent to see whether one should go beyond debt mutual funds and look at the alternatives when it comes to investing in debt products.
Wall St Cheat Sheet: – 4 Tricks for your retirement account. – When you are preparing for retirement, it is a good idea to open up an IRA, given that you can grow your money tax-free until retirement. However, you are limited by the amount of money that you can put into one of these accounts in a given year, and so if you plan on saving more money for retirement you will need to, unfortunately, put money in an account that is taxed at the normal rate.
ETF.com: – How ETF structure comes through in a crisis. – If you haven’t been attending ETF.com’s ETF University webinar series, you’re missing out. We’ve been walking through the ins and outs week after week of how ETFs really work, and Tuesday’s fixed-income session was fantastic.
Morningstar: – Diversification for the sake of diversification. – Vanguard’s Total International Bond exchange-traded fund is a poor investment today.
Bloomberg: – Gross left behind in PIMCO return to top as deputies rise. – Bill Gross promised in May that funds managed by his Pacific Investment Management Co. would be back on top by the end of the year. So far, his prediction is looking good — unless you count the funds that Gross himself runs.
Gross: No country is an island. (Australia excepted). Global trade & growth will be affected by Russia/EU/U.S. trade war — PIMCO (@PIMCO) August 1, 2014
PIMCO Total Return AUM down another $2bil in July — David Schawel (@DavidSchawel) August 1, 2014
Fed’s worst nightmare: 10Y approaching 2.4% handle as stocks drop — zerohedge (@zerohedge) August 1, 2014