Seeking Yield? Look Beyond Treasuries

03/15/2012 6:45 am EST

Focus: STRATEGIES

Income investors have much better options than the now-dangerously-low-yield Treasuries, says Scott Colyer, who shares some of his preferred ideas, and discusses how asset allocation models have changed in recent years.

Kate Stalter: Today, our guest is Scott Colyer, CEO of Advisors Asset Management. Scott, you recently wrote a blog post that I found very interesting, titled “Of Tulips and Treasuries: Treasuries Securities Entering the Bubble Zone.”

So, tell our listeners today what you see happening in the Treasuries market.

Scott Colyer: Well first of all, I think when you look at it from just an absolute viewpoint of where that market’s been over the past ten years, 20 years, 50 years, and 100 years or 200 years, there's only been one point in history, and that was just after WWII, when yields were this low.

For all the other time, yields were much higher than that. So you have to ask yourself, “Potentially, could yields be too low and prices be too high?” And we think they are...for a number of reasons, we think they are.

Kate Stalter: Let's talk a little about how investors should handle that. A lot of people go into Treasuries because they consider them a safe investment. What should these investors be doing right now?

Scott Colyer: Well, with every investor, normally you want to sit back and say, “What is my expected reward and what is my expected level of risk?” And you're absolutely right that this generation of investors has learned to believe that Treasuries offer a risk-free form of investing.

What this generation is missing is that during most of our entire investing lives, we've been in a secular bull move for bonds. So really, it didn't matter when you bought or what maturity you bought. If you started since 1980, you've pretty much been right. That has to do not only with the individuals out there investing, but also professional money managers who invest in bonds.

Really, even their mistakes probably turned out much better than they should have. The Treasury market, really people should look at that and say, “If I want to buy a ten-year Treasury and I'm going to get 2.3% per year for the next ten years,” maybe that's better for them, and maybe that's a fair return.

I would just tell you that the chances of something going wrong are actually fairly high. Right now, we have a Federal Reserve that is actively buying Treasuries as a result of the most recent Operation Twist. They probably are holding prices up and yields down.

In fact, that's their intent, but at some point—probably well within the ten-year horizon of that Treasury investor—they'll stop doing that, and yields will, quite frankly, have a return to normalcy. Normalcy being somewhat higher than that.

Just an example, Kate, that I'd like to point out: if you buy a ten-year note today, and yields go up just by 1%—so from 2.3% to 3.3%—that’s going to cost you about 9% of your principal, because the value of that bond, the principal, will drop by that much. People don't remember that, because this generation has not had to put up with that type of volatility or higher yields in the bond market.

So remember, as the Fed is out there trying to create some inflation expectation, to the extent that they're successful, they will probably cause the Treasury market to return to its more normalized levels over a time period, and that would work against the bond investor.

Therefore, we think there are better places to be. Those better places would be in lower investment-grade paper, would be in high-yield paper, and we even like a lot of the real estate REIT market.

We think that buying that at a time period when you potentially might expect higher inflation in the future is a good place to be. Real estate and the returns on real estate tend to track inflation a lot better than bond prices or bond yields.

Kate Stalter: How about dividend-paying equities? I know some investors have turned to those in this low-interest-rate environment.

Scott Colyer: Dividend-paying equities, the story there is far from over. In fact, once again, you learn not to fight the Fed. The Fed is actually trying to push money out of safer markets into more risk-based markets.

The equity market is at valuations that are very low, from a historic standpoint. Therefore, we think its probably fairly under-owned, so even though the story out there for dividend-bearing equities has been around for a while, we don't think it’s even out of the first inning.

We would say that there are many years and many innings left for that to play out. Remember that the largest demographic group of baby boomers is going to be hunting for income for quite some time, and I think that dividend-paying equities is probably something that will benefit quite nicely from that demographic move.

Kate Stalter: I want to wrap up today just talking a little bit about asset allocation. I see that your company has a number of portfolios that address various strategies and various asset classes. How does a client know which approach is best for him or her?

Scott Colyer: Well, asset allocation means a lot of things to a lot of people, and quite frankly asset allocation can mean different things to investors during different time periods in their investing life.

The old adage of: “You should basically have your age in the percentage to bonds and the balance of a hundred minus your age should be in equities”—that’s kind of the old rudimentary asset allocation. But quite frankly, those models have changed dramatically.

In fact, asset classes that were never before available to individual investors [are now available]—that might include emerging markets. They might include things like business development companies, which are a very specialized 40 Act-type of organization that tends to pay some very nice income returns over time.

Asset allocation models now are very complex, and in fact, as volatility changes over time and evaluation of those asset classes change over time, we try to provide tools that will allow an advisor to adjust that mix for an investor so that they achieve maximum diversification. And they tend to be able to hedge a little bit against things like inflation, which is something we see out there in the future.

Kate Stalter: So it sounds like today, that people have to be a little bit more nimble in terms of making adjustments to different market conditions, not just accept the rote formula anymore.

Scott Colyer: Part of me wants to agree with that and part of me wants to disagree. And the part that wants to disagree is: When I listen and I hear that buy and hold is gone, it’s outdated, it doesn't work, I also believe that trading on an intraday basis and adjusting your asset allocation weekly or monthly is equally as dangerous to an investor.

So an active asset allocation model is important, but how active is really what we're talking about here. And I think quarterly or semiannual rebalancing is really what in investor should be looking at. You know, reconsidering that model quarterly or annually or semiannually. Don't try and do it daily or weekly.

So therefore I would agree with you. You need to be more active than maybe my father’s generation had to be. But on the other hand, I also don't believe you should be doing that three times a day.

Related Reading:

Are Bonds Still a Good Bet?
2 Trophies in the Hunt for High Yields
Don’t Use Stocks as an Inflation Hedge

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