Doug Drabik discusses fixed income market conditions and offers insight for bond investors.
A couple of days ago during our internal Monthly Strategy call, I was joined by one of our corporate bond traders, Mike Petersen. We had the opportunity to answer several advisor questions. Here are some of those highlights:
If someone comes to you with $200,000 to invest in fixed income, what are your initial considerations? Basically there are three necessary qualifiers and these are in no particular order: 1) What, if any are the liquidity needs? Are there cash needs to meet monthly obligations such as living expenses? We can control the amount of cash flow via the coupon we choose on an individual bond. The higher the coupon, the greater the cash flow generated. A $25,000 bond with a 2.625% coupon versus 1.75% coupon generates 50% more cash flow annually. The maturity structure of the portfolio can also be customized to meet specific liquidity needs.
2) Income optimization is a consideration. It is derived in context to 3) the risk tolerance or acceptable credit of a bond. Although we deal mostly in high grade credits, there can be meaningful differences in yield on various investment grade ratings which run from AAA to BBB-.
Once parameters are set, how do we decide between various bond choices which all may meet the criteria? Comparing specific details can highlight the tradeoffs between yield, price, maturity and rating. Analyzing these comparisons can often reveal investor’s comfort and preferences.
Sometimes my statement reflects a loss. I thought bonds were protecting my principal? We are sensitive to the anxiety associated with seeing “red” or losses on your statements. As investors and even as professionals, we are programmed to think in terms of total return. If we buy a stock at $50, we anticipate appreciation and want it to go to $150. Many assets rely on appreciation to capture positive returns. Bonds do not. If held to maturity, we actually anticipate receiving the face value back at maturity. The value in bonds is in the cash flow and income they generate, and most importantly, the protection of principal they provide.
What is meant by ‘trader’ perspective vs. ‘strategic’ perspective? Traders are experts at what they do and the market segment they represent. An Atlanta-based municipal trader trades, studies and masters their specific market. A corporate trader in the energy sector is an expert within that segment of the market. They will have the ability to assess value in micro-fashion within their sector. They will not necessarily lay judgment or opinion on the question asked but rather provide the optimal choice given the parameters.
A strategist will attempt to uncover the answer to the question asked but maybe even the questions not asked. Here is an example using a real estate agent showing two homes. Imagine that both homes are priced relatively the same and both homes would provide comfortable shelter. The buyer is “wowed” by one of the homes and so the choice seems obvious. However, suppose the agent divulges that the “wow” home will need $100,000 in upgrades for a furnace, roof, and irrigation system in the next year. Does this change the buyer’s position? Maybe or maybe not; however, wouldn’t you want to know all those facts before deciding? Fixed income strategists provide a best effort at exposing detail in strategy and/or bond selection by answering direct questions and offering additional information that may be important in the decision-making process. Understanding this information can then assist the trader in optimizing specific bond choices that best optimize client needs/wants.
There are many good questions that circulate. You have a whole team of experts comprising of your personal advisor which includes strategists, analysts and traders in place to assist you with providing the optimal strategies and individual bonds for your portfolio.
To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section of investinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.
The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.
Stocks are appropriate for investors who have a more aggressive investment objective, since they fluctuate in value and involve risks including the possible loss of capital. Dividends will fluctuate and are not guaranteed. Prior to making an investment decision, please consult with your financial advisor about your individual situation.