Why Fixed Income Still Makes Sense

08/02/2012 8:15 am EST

Focus: INCOME

Many investors have shied away from bond investing, citing low interest rates. But Chris Heffernan tells MoneyShow.com why that viewpoint, which has been around for years, can harm portfolios. He also explains why he prefers individual bonds vs. mutual funds or ETFs.

Kate Stalter: Today, I am speaking with Chris Heffernan of SumRidge Partners. Chris, your company specializes in the fixed-income area. I wanted to start out today with the 30,000-foot view of your business model. Are your clients retail investors, institutions, or both?

Chris Heffernan: It's a mixture of a few different types of clientele. First, we do have an investor base of retail wealth advisors—not their clients, but the wealth advisors themselves.

Secondly, we talk to a lot of the high-net-worth private banking clients, like the Morgan Stanley (MS) and the Goldman Sachs (GS) of the world, the Barclays (BCS), Deutsche Bank (DB), etc. All those high-net-worth accounts are typically $5 million and up account minimums.

And then lastly, we talk to institutional accounts. Everything from the very large asset mangers that are in the public eye that everyone knows of, as well as a lot of the smaller, tier two, tier three asset managers, pension funds, insurance companies, etc. So it's a nice mix of clients that share many of the same interests in fixed income.

But certainly the mindset of the wealth advisor clients, compared to some of the institutional clients that we deal with, vary at times.

Kate Stalter: Talk a little about how your approach is differentiated from others. I understand you like to bring a type of an equity mindset to fixed-income investing.

Chris Heffernan: Yeah, we do here. I think that you watch CNBC and you read the papers, how low interest rates are and how being in the bond market is such a terrible idea, and you can't make any money in bonds.

If you just know the bond market and look at the yields on US Treasury bonds, for example, and you look at a US Treasury ten-year bond at a 1.4%, you would say, “Well, why would I ever buy that?”

And people have been saying that for a very long time. I can remember back in 2006, when interest rates—whether it was a two-year or a 30-year bond—were at 5.25% and everyone said, “Why would you ever lend your money to the US government for 30 years at 5.25%?”

And lo and behold, here we are right now. And if you had done that trade—if you had bought a 30-year bond, as an example, back in 2006—you would have returned roughly 90% of your money, including the appreciation in that bond's price, as well as the coupons that you got.

So, there are other ways to make money in the bond market, as opposed to just the stated yield to maturity that everybody knows of. Bonds move up and down in prices. As an example, just over the last five or six months, since March, a ten-year Treasury bond, between the appreciation in its price as well as the coupons that you are receiving, that's up about 9.5%, again since March.

So, anyone that invested in March, when everyone was saying, “Why would you ever by a bond at this low interest rate?”...Well, interest rates went even lower. So, that's just one example.

The high-yield corporate bond market year-to-date is up over 8%. And then in investment-grade corporate bonds, which are a little bit more safe, kind of in-between those two asset classes, those are up anywhere from 3% to 8%, depending on what investment-grade bond you own.

Again, this is all year-to-date, so we still have another half of the year. There are opportunities to make, and to buy and sell bonds in between just the standard buy and hold strategy that a lot of clients have been told about over the years.

Kate Stalter: Are you more in favor of buying individual bonds, whether they are government or corporate, versus some kind of bond fund?

Chris Heffernan: We are. I mean, that's what we do here. We trade investment-grade corporate bonds, high-yield corporate bonds, and municipal bonds.

One of the reasons that we like this strategy over buying ETFs or mutual funds is you don't pay a fee. So if you're a client and you're getting involved in this space, you're not paying these large fees on returns that are already low. The yields on a lot of these bonds are already low to begin with. To pay a management fee on top of that eats away from the kind of income that you can generate.

But, more importantly, you control your own destiny. You control exactly what's in your portfolio. Sure, you're paying an ETF manager, a mutual-fund manager, to be the expert, to know what they're doing.

But at the end of the day, a lot of these ETFs and mutual funds own hundreds of different companies. And if you have an opinion on the economy and an opinion on the general businesses of this country and around the world and you don't like a specific sector, well, then, in your own portfolio, if you control the bond that you owned, you might not be involved in retail if you were negative on the retail sector. But if you're buying an ETF or mutual fund, you're forced to buy whatever the managers are buying.

So if you control your own destiny—if you own the bonds in your own portfolio, and you pick and choose using services like ourselves here, as well as your own thoughts on saying, “OK, I like these sectors, I like these names, I'm going to construct my own portfolio”—we think that's much more advantageous going forward.

Related Reading:

Are Indices Your Best Benchmark?

Using ETFs for Stability and Consistency

The Fix Is In for Fixed Income

Related Articles on INCOME