Home Strategies • Fixed Income: Don’t Get Too Cute

Fixed Income: Don’t Get Too Cute

 - 

I love to play the market. I like to trade, I like to speculate and I like to watch the tickers and listen to CNBC. The problem is that I, like so many others who won’t admit it, I am not very good at it. So what I do is I set aside a small amount of money in my portfolios for trading purposes.

I try different options strategies, take a chance on a name that’s breaking out or something else that generally lasts a week or two. I generally get it right about half the time allowing me to keep feeding my addiction without losing money. Really big secret, right?

When was the last time you read an article about some cute strategy with your fixed income investments? You can normally tell what’s coming by reading the first paragraph. It normally starts with, “interest rates are sure to rise.” Well, duh!

As I write this, I’m watching the Packers game and with less than a minute left in the game, the Packers have the ball and they’re up by six points. I’m now making the prediction that they’re going to win. Well, duh! I’m hardly a football guru coming up with that gutsy call.

incomeRight after such a game changing call, the author often goes on to tell you how you should do something that sounds like an equity strategy because something will happen in Europe, QE 3.5 will happen and something concerning the yield curve will surly cause those high bond prices that we’ve loved for so long to drop because of their inverse relationship to interest rates and that will leave you, the unsuspecting bond investor high and dry.

Well, I have a problem with theories like this. I understand the need for thinking ahead and addressing market headwinds but my overriding philosophy is to respond to what the market is giving me now. Any time I’ve tried to get cute with market timing I’ve found myself on the losing end somehow. I’ve either lost money or spent too much time waiting for a new setup with cash sitting on the sideline.

I read an article just yesterday where the author advocated cashing out of bonds and going in to cash until a setup emerges after the interest rate hike. Here’s the problems with that: First, it’s much too early. Interest rates will go up but probably not any time soon. I wouldn’t advocate listening to somebody who claims to be a terrible market timer but I’m relatively confident that rates will be low for “an extended period” as the Fed has said in every recent statement.

Even if they hadn’t said that, the market isn’t telling us that it will be healthy in a matter of a few months. If the mark of an amateur investor is selling too early, this seems like a perfect example of that.

Next, why would you go to cash? I do believe that it would be ill advised to commit to long dated bonds since interest rate risk is likely to come to fruition and the investor could set themselves up for a large capital loss either realized by cashing out or unrealized by sitting in a low yielding bond until maturity but there are ways to mitigate this.

How about purchasing high yielding corporates of underrated companies? I’m living proof that the low interest rate environment has pushed fixed income investors up the risk spectrum but because of that, I’m ok with longer dated bonds when they’re yielding 7%. Even as interest rates rise, I plan to hold these bonds to maturity and I bought them at a discount anyway so my return relative to interest rates will go from pretty darn impressive to nominal at worst.

Bonds are just like stocks. There are some underrated bonds out there. After careful research I’m confident that my high yield corporates were issued by underrated companies who are being forced to give me some great coupons.

Want a little more flexibility with your fixed income capital? How about keeping your money in bond ETFs until the environment reverts to more of a long term mean? Set a stop loss if you don’t want to own the funds for the long term but you can always change the weighting later on if you get spooked. Don’t try to time it. Position your money in a way that gives you liquid means to respond when necessary.

Here’s my point: there are way too many articles that advocate playing some sort of market timing games with your fixed income allocation. If it doesn’t work with something as liquid as equities, why would it work any better with fixed income? If you think speculation on stock prices is hard, try speculating on interest rates.

Don’t get cute. Take what the market gives you and use your fixed income for what it is: Fixed income. Speculate on your stocks if you must.

Author:Graham