Successful Bond Investing in a Low-Interest Rate Environment

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Cabot Money Management's fixed-income portfolio manager, William Larkin, discusses navigating the complexities of the low-yielding bond market. …

Cabot Money Management's fixed-income portfolio manager, William Larkin, discusses navigating the complexities of the low-yielding bond market.

Disclosure: These seminars are for discussion purposes only. It is not an offer to buy or sell individual securities or investments. Investors should consider their own individual investment objectives, risks, charges and expenses of their portfolio carefully before investing. Investments are not FDIC insured and may lose or fluctuate in value. Please request our Form ADV Part II for complete disclosures.

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  • 1. SUCCESSFUL BOND INVESTING IN A LOW-INTEREST RATE ENVIRONMENT
    Presented by:
    William Larkin, Jr., Portfolio Manager
  • 2. THE YIELD CONUNDRUM
    BONDS are lending arrangements made between a lender (saver) and borrower (spender)
    A
    B
    SAVER
    SPENDER
    Cheap Capital
    Date Certain
    Available Financing
    Income Producing
    Flexibility – Bond Options
    Stable Investment
    Fair & Reasonable Return
    Fair & Reasonable Terms
    DEMAND FACTORS
    SUPPLY FACTORS
    Safety
    Refinancing
    Uncertainty
    Expansion
    Fear
    Acquisition
  • 3. THE ECONOMIC CYCLE
    Peak
    Financial System Imbalance
    Early Recession
    Late Expansion
    Strong Buying Demand
    Late Recession
    Early Expansion
    Trough
    Strong Selling Pressure
  • 4. WHERE ARE WE TODAY?Macro Perspective
  • 5. WHERE ARE WE TODAY?Micro Perspective
  • 6. TYPES OF BOND RISKS
    The Greatest Hazard Is To Take NO Risk
  • 7. THREE PRINCIPLES THAT DETERMINE A BOND’S RETURN
    #1 LIQUIDITY
    #2 CREDIT
  • 8. #3 DURATION RISK
    Time
    Low Variability
    High Variability
  • 9. #4 REINVESTMENT RISKS
    Time
    Causes
    Market Timing
    Being To Defensive
    Bonds are Called Away
    Principle Payments Accelerate
  • 10. WHAT EVERYONE WANTS IS IN CONFLICTWITH WHAT THE MARKET IS OFFERING
    Return
    Certificates of Deposits
    US Treasury Bonds
    Liquidity
    Safety
    High Yield Bonds
  • 11. RISK-ADVERSE INVESTORS ARE LINING UP FOR NEGATIVE REAL RETURNS
    Solutions
  • 12. WHY HAS DEMAND FOR ZERO SKYROCKETED?
    Part I
    In Behavioral Finance there’s a term called Risk Intolerance, which is defined as market conditions when investors refuse to take risk to earn a return. An abrupt shift in risk tolerance is similar to passengers on a ship all moving to one side of the ship at the same time. Things obviously become unstable.
    3-Month T-Bill
    Yield = 0.15%
    1-Yr Treasury Bond
    Yield = 0.23%
    6-Month T-Bill
    Yield = 0.19%
  • 13. LOW INTEREST RATES STIMULATES ECONOMIC GROWTH
    PART II
    LOW INTEREST RATES DRIVE DOWN BORROWING COSTS AND CREATE CHEAP CAPITAL
    SAVERS ARE FORCED TO SEEK HIGHER-RISK OPPORTUNITIES
    HIGHLY LEVERAGED ENTERPRISES AND HOUSEHOLDS CAN ENJOY ATTRACTIVE
    RE-FINANCING OPPORTUNITES
    GOVERNMENT INTERVENTION
  • 14. RETURN SCENARIOS
    Investment Objective: Seek a Fair and Reasonable Return
    High Yield (H0A0) 7.95% (Yield) +631 (Spread)
    Emerging Markets Debt (HaD0) 7.07% (Yield) +519 (Spread)
    Fixed-Rate Preferred Sec. (P0P1) 5.13% (Yield) +178 (Spread)
    US Corp Bonds (C0A0) 3.84% (Yield) +185 (Spread)
    Municipal Bonds (U0T0) 1.97% (Yield) +58 (Spread)
    Asset-Backed Securities (RoFo) 1.57% (Yield) +153 (Spread)
    Mortgage Backed Securities (MoAo) 2.63% (Yield) +47 (Spread)
    US Agency Bonds (UAGY) 1.39% (Yield) +28 (Spread)
    US Treasury Bonds (G0Q0) 1.55% (Yield) (Zero Spread)
    US T- bills 0-3 months (G0B1) 0.13% (Yield) (Zero Spread)
    Spreads a/o 9/15/10
  • 15. THE EXTREME COST OF SAFETY HAS REDUCED THE EARNING POWER OF BONDS
    High Yield Bond = $7,950
    Corporate Bond = $3,840
    Mortgage Back Security = $2,630
    US Government Agency = $1,390
    US Treas. Security = $1,550
    US T-Bill = $130
    Based on a $100k Investment
  • 16. ECONOMIC RECOVERY COULD BE A SERIOUS PROBLEM FOR RISK- AVERSE INVESTORS
  • 17. The Alarm Bell is Sounding
    #1 Mutual fund inflows (Heavy Buy Activity  End of Cycle)
    #2 A recovery will limit fear and uncertainty (Reduce Demand)
    #3 Inflation Expectations will Rise (Negative Real Returns)
    #4 Bond Yields will have to Rise to attract investors
    #5 Bond returns need to be fair and reasonable (Important Logic)
  • 18. Defense Against Credit Events
    Diversification (Utilizing Multiple Asset Classes)
    Seek Strategies W/O Specific Limitations (Avoid the Box)
    Utilize High Yield Strategies (3 Types)
    Individual Corporate bonds (Insulation)
    EEM Debt (multiple options w/diff. Risk Characteristics)
    Exploit the Grey Areas (Between Income and Equity)
  • 19. QUESTIONS?
  • 20. US GDP (1970 – 2010)
    Recessionary Periods
    1975
    1980
    1982
    1991
    2008
  • 21. Threshold Returns
    5% (BBB Corp.)
    3% (Muni & A Corp)
    17-Yrs
    12-Yrs
    7 - Yrs