We already own quite a bit of preferred shares issued by Annaly Capital Management (NLY), but I'm re...
No Bubble in Bonds
08/07/2012 10:00 am EST
Despite the low yields, fixed income provides insurance against financial and economic shocks, says Michael J. Cuggino, president and portfolio manager at Permanent Portfolio Family of Funds.
We have had a terrific bull market in the bond market lately, but is that coming to an end finally and once for all? My guest today is Michael Cuggino to talk about that. So Michael, I know you have Treasuries in a conservative fund like yours. Why have them now, and what do you see here in terms of that bull market?
Well, we own bonds-Treasuries of varying maturities and high-grade corporate bonds-as a diversifier to protect against deflation, devaluations, delivering, liquidity crises, depressions, etc. So as a properly diversified investor, it is one risk we seek to guard against, and holding bonds in a portfolio helps you to mitigate that risk.
Certainly, bonds have been in a multi-year bull market. There is no guarantee when that is going to continue or end, and clearly investors have to be concerned about that.
But from our standpoint, there is a broader rationale toward holding them. It's that structural reason to hold them to protect against deflations and the like, and marrying that up with the realities of the marketplace. So, trying to find the right balance between risk and reward in the bond market, flexibility and longer-term holdings, etc.
In an asset allocation portfolio like yours, do you find your investors are saying, "We need to add more bonds; it's the hot market right now?" Do you feel the pressure that way sometimes?
In this environment, they are saying the opposite, that you need to get rid of them. I think we stress to tell investors that yes, on a historical basis, they are probably overpriced.
However, in this environment-unless you can tell me with certainty that we are done with recessions, depressions, and balance sheet issues-then you need some bonds in a diversified portfolio, and you want to balance out the risk and return on the yield curve. So that is what we are telling investors, and we think it is a prudent approach.
I would argue that much has been made about this bond market being a bubble. I wouldn't call it a bubble so much as I would call it a prudent reaction by many investors to the economic and political circumstances that we are currently dealing with.
Even at shows like this at the MoneyShow, often investors are chasing the hot market long after it has had its run-up. Do you feel like that is where it is with the bond market? Are people exiting now and they are realizing that it is over?
No. I think with bonds, it is not so much a hot market, but it is a safety trade and that investors are going towards the safety of Treasuries.
Every time you see some sort of issue in the world, whether it is Europe or our own economy or something, you are seeing investors flock towards Treasuries. Yields go down, prices go up. So it is more of a fear trade and a safety trade, and we all know that Treasuries are guaranteed.
Now we can argue that the economic effect of that guarantee becomes less every day, as we print more money. But that guarantee still does exist today, and so investors are seeking that conservative protection. So not quite flocking to the hot asset, but maybe more of a safety trade.
All right, then. Switching gears a little bit: I saw a news article the other day about what are we doing to regain our AAA rating now that it has been almost six months or a year since we have lost it. Is it important? Does it play at all into your decision making?
Two questions there. I'm not sure we are doing anything yet to regain the rating. Certainly from a fiscal standpoint, a spending standpoint, business climate standpoint, I don't think we have done anything, and economic growth appears to be anemic at best.
The other issue would be more does it matter? And I think no, it doesn't. I think from a pride standpoint, it was a bad thing to say that we got downgraded, but the ratings were somewhat of a subjective analysis anyway.
In my view they have always been somewhat meaningless, and I think that was borne out by what happened in the last few years. And so the marketplace determines what the right pricing and yield is for a bond-not necessarily an artificial indicator like an S&P, or a Moody's or Fitch, or somebody.
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