How to Help Today’s Bond Investors

Treasury bond investors got it bad and that ain’t good.

Five-years after the worst financial crisis of our generation, the yield on 10-year U.S. Treasuries has already fallen 33.58%.

Not only is that well beyond the generally accepted definition of a 20% bear market, but the 33% reduction in yield income serves as a rough approximation of the income blow that Treasury bond investors have suffered through. (Bond investors holding 30-year Treasuries have taken a 28% income hit over the same five year time frame, June 2009-June 2014)

A shortage of retirement income is one of the biggest predicaments facing Baby Boomers and a few years ago, the Center for Retirement Research at Boston College pegged it as a $6.6 trillion conundrum.

The center’s analysis took into account major sources of retirement income like Social Security, traditional pension plans, personal savings, and 401(k) retirement plans. And even after adding up all these sources, people were short on retirement income. And the low yield, low rate environment is exacerbating the income shortage.

You can throw a rock and hit any of the many analysts on Wall Street that have wrongly predicted higher interest rates. Although such conditions would help income investors to squeeze out more yield, advisors need to prepare their clients for the other scenario – a market environment where ultra-low interest rates persist. What are the chances this happens?

The International Monetary Fund (IMF) gave its latest outlook of the U.S. economy and how it believes that zero percent short-term interest rates could persist even longer than the Federal Reserve is projecting. The IMF’s research noted:

“The Fed currently has to contend with multiple areas of uncertainty: the degree of slack remaining in U.S. labor markets; the extent to which this slack will translate into future wage and price inflation; and the transmission to the real economy of a future move upwards in policy rates. These substantive ambiguities make the outlook for U.S. monetary policy particularly uncertain, as the Fed has repeatedly communicated. At the same time, longer-term treasury yields and the term premia have been compressed to very low levels. Under the staff’s baseline, the economy is expected to reach full employment only by end-2017 and inflationary pressures are expected to remain muted. If true, policy rates could afford to stay at zero for longer than the mid-2015 date currently foreseen by markets.”

Never mind what the IMF thinks about interest rates – I threw it in there to give this article some color. Besides that, the IMF is bound to be just as wrong about the direction of rates as the rest of us.

Simultaneously planning for two opposite extremes – one of higher interest rates and one of lower – is a Herculean task. But isn’t that why bankers get paid the big bucks? Advisors should always be addressing the client’s problems today, while anticipating tomorrow’s problems.  

An immediate solution for the 33% income shortage that Treasury investors are facing is to look at alternatives. This includes high yielding sectors that do well during low rate conditions like utilities (XLU), master limited partnerships (AMLP), and real estate investment trusts (VNQ). It can also mean employing high income strategies like selling covered calls to generate income on top of income derived from stock dividends and bond yields.  

The future solution for a rising rate environment will involve capital preservation by sticking with bond funds and ETFs that have maturities of less than 10-years. It may also involve strategic hedging via ETFs that are designed to increase in value when bond prices fall because of rising yields. (See TBT and TMV.)

Ultimately, the exact solutions you choose will depend upon what you determine is best for the client.

In the meantime, Treasury investors are screaming for help and if they’re not, they either not paying attention or they’re dead. Go help them! (The ones that are alive.)