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  1. Home
  2. / Markets
  3. / Rates and Bonds

Where Investors Should Look for Safety and High Yield

Advisers say investors seeking safety and a yield greater than 3% could consider these two asset classes.
By ROBERT POWELL
May 27, 2018 | 10:00 AM EDT
Stocks quotes in this article: SRLN, VRP

Investors seeking safe fixed-income investments that have a current yield greater than 3% need to consider this above all else: "Safe," says Ken Waltzer, the managing director of KCS Wealth Advisory, "is a relative term."

There are, as most fixed-income investors know already, two main risks in buying bonds:

The first is interest rate risk, which is the risk that the bond price will fall in value when interest rates rise. This can be quantified with "duration," says Waltzer. Duration provides a time-weighted measure of a security's cash flow in terms of payback.

The second is credit risk, which is the risk that the issuer will default in principal or interest payments. "U.S. Treasuries, by definition, have zero credit risk," says Waltzer. "Ten-year Treasuries do, however, have significant interest rate risk, with a duration of about 8. This means that a 1% rise in yields will cause the bond's price to fall by 8%."

Currently, the 10-year Treasury is yielding 3.07%. And, in order to get a higher yield, Waltzer says you need to incur either interest rate risk or credit risk.

"At the current stage of the economic cycle, we believe that the safer course is to take some credit risk and minimize interest rate risk," he says. "This implies bonds that are of shorter (lesser) duration but do have some default risk during a recession, which we think is still a ways off."

With that background, here are some investments Waltzer say you mind consider:

Senior floating rate loans: These are issued by banks to less-than-investment-grade companies, but are very well collateralized and have very short durations. They can be purchased through ETFs or mutual funds. One example is SPDR Blackstone/GSO Senior Loan ETF (SRLN) : yield 4.05%, duration 0.1.

Floating rate or fixed-to-floating preferred stocks: These are issued by corporations, and though called "stocks" are more properly viewed as bond equivalents. Though typically of long duration, there are a number that are either floating rate or have a fixed rate for a period before converting to floating rate. They trade individually or in funds or ETFs. Example of the former: Wells Fargo & Co. (WFE.PRA), yield 6.17%, duration 1.7. Example of the latter: PowerShares Variable Rate Preferred Portfolio (VRP) : yield 4.36%, duration 3.5.

Waltzer says other options such as high-yield (junk) bonds and emerging market debt are riskier in terms of both interest rate and credit risk, and the latter also has currency risk.

A Contrary Point of View

Another investment adviser has a contrary point of view. "I take a pretty long-term, strategic view of investing," says Bob French, the director of investment analysis at McLean Asset Management Corporation. "Tactical adjustments to your portfolio just lead to problems in the long term -- and most of the time in the short term as well."

His advice: Build your portfolio around the fundamental, long-term, risk and return relationships that drive the markets. "Furthermore, focusing on generating current income from portfolio distributions is counterproductive," he says. "There is simply no advantage to generating income from your portfolio in the form of distributions, rather than simply selling from your portfolio to generate your income."

From an economic standpoint, French says it doesn't matter how you take income. It's still money coming out of your portfolio.

"Income investing distorts your portfolio by forcing you to chase yield, and not the fundamental risk and return relationships that drive the long-term returns that you want to harvest," he says. "Income investing can also lead to higher taxes, as many distributions are taxed at your ordinary income tax rate, rather than the lower capital gains rate you would pay when you sell a security."

This article was originally sent to subscribers of TheStreet's Income Seeker, a product presenting the world of opportunities in fixed income and dividend stocks. Click here to learn more about Income Seeker and to receive articles like this from Robert Powell, Peter Tchir, Jonathan Heller and others.

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TAGS: Fixed income | Investing | Rates and Bonds | Markets | Treasury Bonds | ETFs | Funds | Bond Funds | Dividends | How-to | Preferred Stocks | Risk Management

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