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Portfolio Strategies for Today's Tough Bond Market

Christine Benz

Benz: I would like you to step back and give us the broad view, because I think a lot of bond investors feel like they are walking a tightrope right now. So they're concerned maybe about longer-term interest rate hikes; short-term, if the economy continues to muddle along here, what could that mean for some lower-quality bonds?

So, I'm hoping you can share your thinking on fixed-income strategies right now, some of the key takeaways that you impart to your clients?

Stevens: Sure, and I think again it's a great question, because we talk about this all the time. I think the one comment I hear frequently from my clients is they really don't understand the bond market. Stocks they have been exposed to most of their working lives, but bonds, it's a big mystery a lot of times. And to me diversification on the bond side is equally important to diversification on the stock side.

So one thing we have seen in the last couple of years since we have had so much economic uncertainty is a number of clients that are more high net worth would typically have huge portfolios of muni bonds. I think as long as you are in the higher-rated muni bonds, there is less chance that you will have a problem, although those ratings change frequently, and sometimes the ratings really can't even be relied on.

But one thing we're doing is we are saying, let's not have more than half the bond portfolio in munis, first of all, because interest rates are all so low that there is not a huge tax difference in a lot of cases. So, we are trying to keep diversity between muni bonds, corporate bonds, Treasury bonds. And Treasuries are an interesting topic, too, because even though the Treasury debt was downgraded in August, it's still one of the safest places out there, and we have certainly seen a lot of people in the flight to safety move into Treasury bonds. And so I think there is a place for them.

I think an important thing to keep in mind is that you want to have relatively low costs when you are dealing with your bond funds, and there are a lot of good ones out there, but my bias would be let's make sure they are at a low cost.

The other thing to think about is when would you use individual bonds, and maybe even in particular munis and corporates, and I think typically if you have about $250,000 or more that you want to put into that area, you can get a nice diversity of individual bonds. And some people feel like that's a good strategy in this time because you can hold on to those individual bonds longer term. You have to be careful what you are buying right now because rates are on the low side, but if you go out in that 6- to 13-year period, you can get a reasonable return and then just hold those bonds until they mature.

Benz: So you forgo [having to pay] that management fee and then also you don't have that threat of interest rate shocks roiling you as bond fund investors would have?

Stevens: Right and I think the other thing that we have seen is when we do have lots of activity in the bond market, like when Meredith Whitney came out on 60 Minutes and talked about ... a disaster coming in muni bonds, we saw a big exodus from muni bond funds, which then can push down the NAV on those funds, and you saw money being lost when people exited the funds. So there is that uncontrollable factor of "what are other people going to do?" Even if this fund is sound and the philosophy works, you just never know what could happen because of other people leaving the fund at the wrong time.

Benz: Right, especially in the muni categories, it seems, where retail investors are such a big share of the overall base.

Stevens: Right.