Maintaining a Disciplined Approach in Challenging Times

Fixed-income investors are now passing through the most painful and dangerous part of the interest rate cycle.  The pain is coming from the prolonged absence of investment yield.  It has now been almost two years since the Federal Reserve dropped its short-term rate target to 0-0.25%, effectively pinning all short-term yields near zero.  Longer-term rates have also dropped, particularly given recent doubts about the sustainability of economic recovery in the United States.  The danger arises from impulsive investors doing too much to add yield by assuming a substantially higher level of credit risk, or by extending portfolio maturities to capture the benefit of the upward-sloping yield curve.

We are now well into the Fed’s current policy cycle and Treasury yields are at historically low levels, so the potential for market-price increases in bonds is quite limited.  At the same time the markets have a history of anticipating (some would say forcing) changes in Fed policy.  For example, in the one-year interval between the Fed’s last cyclical ease in June 2003 and its first target rate increase in June 2004, yields on 5-year U.S. Treasury notes rose by more than 1.6% and on 10-year notes roughly 1.4% from their cyclical lows.  Market yields moved up well before the Fed acted.

SNW Asset Management has not been idle as rates have fallen, nor have we over-reached for yield.  Over the past 2 years we have opportunistically added yield through selectively adding securities that offer higher yields while maintaining portfolio durations.  For example, investors in taxable bonds may have noticed a modest increase in the level of their credit risk via the careful selection of corporate credits and sale of short maturity bonds.  Because of these trades, we have been able to increase the yield on our client portfolios while keeping them concentrated on the steepest sections of the intermediate yield curve (3 to 4 years).  Clients invested in tax-exempt bonds may have noticed that a select number of healthcare and public utility credits were added to their portfolios.  In some cases we used funds from maturities to make these shifts.  In other cases we sold short maturity bonds, which allowed us to book profits and increase yield.  These subtle shifts in allocation have added value without adding unacceptable amounts of either credit or interest rate risk to our client portfolios.  As with all of the relative value swaps we implement, the trades are executed with each individual client’s mandate in mind.  For this very reason, we encourage all of our clients to take a moment to revisit their Investment Objectives to ensure that the portfolio objectives and risk tolerances we have on record are up to date.

SNW Asset Management would like the opportunity to review your investment objectives with you to assess which of our recommended approaches to the current market is appropriate.  We welcome your phone calls and look forward to having a discussion with you.  Please click here to find a copy of our Investment Objectives form, which outlines the key characteristics of the strategies we offer.