Archives for June 16, 2016

Reasons For Owning High-Quality Bonds

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pie_flat_blank_200Here are some helpful resources on owning only bonds of the highest credit quality as part of your portfolio asset allocation.

  • David Swensen in his book Unconventional Success argued that alignment of interests is important. With stocks, the exectives want to make profits, and you want them to make profits. With stocks, your interests are aligned. In contrast, the job of bond issuers is to look as creditworthy as possible, even if they are not. This keeps the interest rates they pay lower. With bonds, your interest are not aligned. The safety ratings of bonds usually only get worse – usually quickly and unexpectedly as we saw with subprime mortgages. Ratings agencies are not very good at their jobs, mostly in a reactionary role, and are often paid by the same people they rate.
  • Larry Swedroe at ETF.com:

    However, he also observes that the primary objective of investing, at least in stocks, is to make money. On the other hand, he makes an important distinction when it comes to the primary objective of investing in bonds, which is to help you stay invested in stocks when the inevitable bear markets arrive.

    And that leads to his conclusion to invest the fixed-income portion of your portfolio in only the safest bonds (such as Treasurys, FDIC-insured CDs and municipals rated AAA/AA).

    The overall idea to is own the safest thing possible when it comes to bonds.

  • Daniel Sotiroff at The PF Engineer:

    The primary reason most investors own fixed income securities (bonds) is their ability to limit declines in portfolio value during periods of poor stock performance. From this perspective there is another dimension to safety in the fixed income universe that needs to be understood.

    […] Almost all of the non-Treasury securities experienced a drawdown during 2008 which peaked around October and November. Investors holding corporate bonds, intermediate and longer term municipal issues, and inflation protected securities were no doubt disappointed that their supposedly safe assets posted losses. Corporate bonds in particular have the unfortunate stigma of behaving like stocks during crises. Adding insult to injury those disappointed investors were also faced with taking a haircut on their fixed income returns if they wanted to rebalance and purchase equities at very low prices. Thus there is more to risk than the more academic standard deviation (volatility) of returns.

    My interpretation is that he concludes that intermediate-term Treasury notes are good balance of safety and interest rate risk, while short-term Treasury bills are for those that really don’t want any interest rate risk.

  • Also see this previous post: William Bernstein on Picking The Right Bonds For Your Portfolio
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