2 Ways to Move Out of Fixed-Rate Debt

06/27/2011 3:00 pm EST

Focus: BONDS

Richard Lehmann

Publisher, Forbes/Lehmann Income Securities Investor

Rotating into adjustable-rate securities may be the smart move in this market, but where to go? Not TIPS…Richard Lehmann, in this exclusive interview with MoneyShow.com, explains his preferred strategies.

What should investors being doing to set themselves up for the upcoming end of quantitative easing and the stimulus that the Fed has been doing?

Well, the expectation is that interest rates are going to be going up. It's only a question of how quickly and how much, but since the trend is upward, there are certain areas where investors should be diversifying into in anticipation of those rates going up.

What areas are you looking at?

The areas we're looking at are, for example, moving out of fixed-rate securities and into adjustable-rate securities. Adjustable rate meaning debt securities where the payout rate is reset, either monthly or quarterly, based on either the LIBOR consumer price index or some other treasury-rate index.

Like a ten-year Treasury or something like that.

By the way, in that respect the TIPS investments—which tend to be a favorite one for individuals because they're a US treasury debt—are not one of the good alternatives, simply because they're overbought. At the present time, they yield less than 1%, and they're tied to the core CPI rate, which is not the better rate you want to be indexed to.

Also, the appreciation you get from inflation is not paid out to you in cash, but is taxable. So they are not really tax advantaged in that respect, but the ones that are in the general market place are paying it out as they are creating that volume.

So get out of TIPS if you hold them. What do you do with that money?

Well, there are other securities. Most of the banking institutions put out adjustable-rate debt securities traded on the New York Stock Exchange. They trade as preferreds, but they're actually debt securities.

There are also several closed-end funds that specialize in adjustable-rate debt. They are actually a good option because the adjustable debt securities currently yield on a 4% range, whereas the funds that invest in these securities—because they're leveraged and they have better selection of securities—will yield 7% or 8% today.

Therefore, they have inflation protection, and getting 7% to 8% today is a dream come true.

Do you have any suggestions or some recommendations?

One particular closed-end fund is Highland Credit Fund (HCF), which yields 8.3% and yet offers very good inflation protection.

Any other ones?

I would refer people to our Web site. We do list in there everything that we've ever recommended, and we also run model portfolios of securities, some of which will include these adjustable rates. I can tell you that there is a large universe of these, and people should be looking at them.

We face a unique situation here, in that we've got a clear signal from the Federal Reserve that they expect inflation to increase, and that has to translate into interest-rate increases. So it's rare that we get that kind of a signal from the Federal Reserve Bank.

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