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A Shot in the Arm for Income Investors

05/04/2012 7:30 am EST

Focus: BONDS

Marilyn Cohen

President & CEO, Envision Capital Management, Inc.

Finding a decent yield continues to be like looking for the Burmese albino rhino, but be patient and be prudent and yield envy will pass, writes Marilyn Cohen of Bond Smart Investor.

Wonder what PTYD stands for? Post-Traumatic Yield Disorder.

This insidious epidemic has struck down fixed income investors of all types: those investing in CDs, Treasuries, corporate name it. Some psychiatrists are prescribing the drug Scale-ndra as a cure. This blockbuster drug requires bond investors to scale their durations and go further out on the maturity curve in order to pick up yield.

Scale-ndra’s side effects can be very deleterious, though. If interest rates shift and bond prices decline, Scale-ndra will cause portfolio erosion. The chain reaction can be sleepless nights, night sweats, intestinal motility, worry, and some people even experience weight gain.

Another Wonder Drug
Other psychiatrists prescribe Creditmycin. Creditmycin has been around for years—in its brand name (individual junk bonds) and in generic form (exchange traded or open-end junk bond funds).

Side effects are similar to Scale-ndra, but with on additional problem—liquidity. When the market turns and credit spreads widen, or when defaults increase, bids disappear. When bids disappear, there’s no stomach pump powerful enough to make them reappear.

A Cocktail Solution
As a prescribing practitioner, I believe a combination cocktail of the two is a better antidote. Down a modicum more of duration and a fractional increase in lower credit quality in order to increase your portfolio yield. Don’t expect any total return this year. Should that accidentally happen, consider it a gift.

It’s extremely distasteful and agitating to recommend a four-year investment-grade bond (A+) yielding less than 2%. Take a dose of Scale-ndra (longer maturity) and go out eight years, and maybe you can capture a 3% yield. You can see our Investment Grade Recommendations for more.

Moderation Is the Key
Knowing 3% is the new 5% under the Federal Reserve’s easy, plentiful, flowing monetary policy—a corporate bond yield of 3% for eight years may cause portfolio nausea.

Here’s where the cocktail combo comes in. Dip down in credit quality (Creditmycin) and take a few doses of some of our High Octane Recommendations. Do not overdose on any single name.

Stick to a maximum 5% allocation per name and a sector allocation of 15% to 20% to financials, energy, retail, pharma etc. This way, your portfolio can maintain itself even if one position totally gets nuked.

It’s true, you don’t make big money by taking this measured, cocktail combo approach. But the big bond money has been made in this cycle, and the next cycle is not yet upon us. But it’s coming. Preservation of capital, yield, and diversification are the side effects I am seeking.

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Related Reading:

Look Beyond the Usual Dividend Suspects

A Smart Way Back Into Real Estate

3 Income Strategies the Don't Work

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