Bonds #3: Flexibility in Bond Investments
In case you missed it, we are in the midst of a little series looking at the problems with alternatives to bond investments. Strangely enough, last week I began looking at alternative investments by examining the use of bonds to replace bonds in your portfolio.
Yeah, it doesn’t make much sense until you realize that most people who invest in bonds mostly put their money into investment-grade intermediate-term bonds of the US Government (if they are conservative), municipalities (if they are in a high tax bracket), or corporations. This leaves a number of other areas of the bond market open to consideration.
Last week, we looked at taking more risk to try to get more return via junk bonds, reducing risk by using shorter-duration bonds, or going overseas. While each added diversification to a bond portfolio and helps in some area, each one also added or exaggerated problems in others. In other words, you don’t get to have your cake and eat it, too.
So now I’m going to share my method of mitigating the risk of future interest rate rises or other economic events that can hurt bond returns or even cause you to lose money in your bond portfolio. I let someone else worry about it.
Yes, I know I’m the investment dude, and you think I know it all and can do it all. Well, I can’t. I’m good, but I’m not that good. And honestly, the bond market is a lot more difficult to analyze and manage. So, while I will use individual bonds or single-maturity funds for parts of a portfolio, the bulk of my bond investing is through strategic income funds. These are mutual funds or exchange-traded funds that can invest across a wide variety of bond types from conservative to wildly aggressive and from ultra-short durations to long-term. Domestic, foreign, and even emerging market bonds find their way into these portfolios. In addition they might use many vehicles and techniques such as shorting bonds (taking a negative position in them, hoping for a decline) and using convertible bonds (bonds that can be converted to stocks), to name a few.
Now, these are not a panacea. You have to do your homework. Just because these funds purport to use strategies that lower risks or raise returns compared to the bond market as a whole doesn’t mean they get the results. Even if they have had favorable returns they may be taking more risk than you are comfortable with to get there. Many are relatively new and therefore harder to research, so I suggest sticking with those from companies that have a long and stellar history in all of the smaller sectors of the bond market.
Okay, that wraps up talking about how to replace bonds with bonds. But there is another group of investments people use more frequently these days as a replacement for some of their bond holdings: Alternative investments. We’ll discuss them next week.
This article was published under the title "Here's my secret for handling bond risk" in the WichitaFalls Times Record Newson July 28, 2013.