ILNews

Confronting shrinking interest rates

Back to TopCommentsE-mailPrintBookmark and Share

You know the investing climate is unusual when a stock’s dividend yields more than bonds issued by the same company.

Take Indianapolis-based oil refiner Calumet Specialty Products Partners LP, whose dividend-paying stock had an annualized yield in early December of 8.23 percent, while its bonds yielded 7.21 percent.

Many better-known, blue-chip stocks crossed the same threshold as bond prices continued to rise last year. An overheated fixed-income market would be yet another challenge for income-seeking investors, who’ve had few low-risk options in the era of rock-bottom interest rates.

yield_table.jpg“Without question, this is the hardest environment investors have seen, probably in our lifetime,” said Terry Weiss, president of Wallington Asset Management, an Indianapolis firm that handles more than $400 million for wealthy individuals. “And it’s coming at a difficult time because, what do you have? You’ve got a lot of people who are retiring.”

Local investment pros have different strategies, but they offered a common thread of advice: Don’t assume fixed-income means no risk.

“The last place you want to experience a loss in your portfolio is in the portion you thought was the safe piece of it,” said Brad Cougill, a partner at Indianapolis-based Deerfield Financial Advisors, which oversees $476 million for clients.

Investors poured more than $456 billion into global bond funds through Dec. 5, and $72.4 billion of that went into high-yield funds, or junk bonds, according to Boston-based EPFR Global, which tracks fund flows.

Money gushed harder toward bonds than in 2009 and 2010, when the total inflow was $354 billion.

The risk for bond investors is that yields are so low, even a slight rise in interest rates could erase the return, and continually rising rates could erode principal.

Cougill thinks the bond market will see some volatility over the next year, and he dispensed the same advice about sticking to an asset-allocation strategy that one often hears in the context of stock-market swings.

“I think people need to be prepared for that and know what they’re going to do,” he said.

With top-rated bonds yielding less than 3 percent, high-yield, or junk bonds became more attractive in 2012. Many of those bonds were held in new mutual funds and exchange-traded funds (which trade like stocks).

Winthrop Capital Management in Indianapolis looked closely at funds yielding 6 percent and found that most of their holdings were rated B or BB and yielded less than 5.5 percent. The remainder, which drove the overall return, went to bonds with double-digit yields.

“That’s the toxic stuff, and it has a high probability of defaulting,” Winthrop President and Chief Investment Officer Greg Hahn said.

Hahn isn’t against high-yield investing, but he said, “The question to ask is whether you’re getting compensated adequately.”

From a historic perspective, the answer to that question is no, he said. The yield spread between 10-year Treasury bonds, the safest investment, and junk bonds was near its tightest level in a decade in early December, he noted.

With interest rates near zero, the duration of a bond is as important to consider as credit quality, Weiss said. He doesn’t think interest rates will rise soon, but like other local wealth managers is careful not to invest in bonds going longer than five years.

Retail investors should look for bond mutual funds with durations no longer than five years, Weiss said. And given the low yields, he said, “I would be certain to be investing in mutual funds which have a very competitive fee structure.”

Fear of stocks justified?

The flight to fixed-income reflects a wariness of the stock market that’s persisted since the 2008 financial crisis.

“A lot of people are still running scared of the world, of the economy, of Washington,” said Don Woodley, principal at Woodley Farra Manion Portfolio Management in Indianapolis. “The safe industry is doing a bang-up business.”

Deerfield clients’ stock-market fears prompted the firm to adjust portfolios more toward high-quality bonds last year, Cougill said. As a result, total returns ranged from 5 percent to 8 percent.

“The stock market is up higher than that,” Cougill acknowledged. “But clients are saying, ‘Well that’s OK. We’d rather give up some of that upside.’”

Money flowed out of stock funds last year even as the Standard & Poor’s 500 posted double-digit returns. Investors pulled $67 billion out of equity funds through Dec. 5, according to EPFR Global, while the S&P 500 index returned 16 percent through Nov. 30.

Woodley, for one, thinks investors are missing an opportunity by sticking with what they see as safe havens. “Somehow people equate bonds with safety, and that’s not necessarily the case.”

Another option for investors looking for low-risk income is dividend stocks. Woodley, whose firm set up a dividend-stock mutual fund in 2011, looks for companies that not only pay dividends but increase them.

“It doesn’t have to be every year,” he said. “In a good year, they should be increasing their dividends and paying more and more to you.”

Utility stocks are an obvious source of dividends, and some yield 4.5 percent to 5 percent, Woodley said. (Dividend yield is the annual dividend per share divided by the share price.)

Utilities wouldn’t be attractive without the regular payments to investors. Earnings might grow 3 percent to 4 percent a year, Woodley said. “That’s good growth for a utility.”

Woodley also likes counter-cyclical companies like diaper and toilet-paper maker Kimberly-Clark, which has raised its dividend each of the last five years. The company’s earnings have also risen, an average 10 percent over five years, he noted.

“That growth is not spectacular. It allows an investor to rest comfortably,” he said.

Money managers like preferred stock because the dividends must be paid, even if earnings drop and the company cuts payments to common shareholders.

Preferred stock can seem as safe as a bond because it’s assigned a maturity date and par value, but there are risks, such as buying close to the call date, Woodley warned. “People can actually lose money if they buy the wrong preferred stock.”

Banking is another place to find rising dividends, though some money managers rule out the industry as too closely tied to potential economic shocks. For Hahn, who also likes preferred stock, banks are the only option to consider after utilities.

Each bank has a different risk profile, based on its particular niche and business strategy, Hahn said, so there’s no reason to rule them out.

“For decades, we just painted the brush over the whole industry,” he said.

When it comes to stocks in general, Hahn, who advises mostly institutional clients, is an uber-bear. At best, he thinks stocks will stay flat until global demand picks up, and he doesn’t think that will be in 2013.

“There really is no scenario we can come up with where stocks go on a roar,” he said.

Kip Wright, managing director at Kirr Marbach in Columbus, takes the opposite view.

“I think equities have the best potential going forward,” he said.

Finding sub-investment-grade bonds with upside potential became more difficult last year, he said. Yet investors still want returns of 5 percent to 7 percent, he said. “The only place you’re going to get those returns is by layering equities into your portfolio.”

Before the 2008 financial crisis, clients were willing to ride out events like the federal government’s fiscal cliff, Wright said. Lately, they can think only about locking in short-term returns.

“Looking for those guarantees are costing people a lot of money in this environment,” he said.•

This story originally appeared in the Indianapolis Business Journal.

ADVERTISEMENT

Post a comment to this story

COMMENTS POLICY
We reserve the right to remove any post that we feel is obscene, profane, vulgar, racist, sexually explicit, abusive, or hateful.
 
You are legally responsible for what you post and your anonymity is not guaranteed.
 
Posts that insult, defame, threaten, harass or abuse other readers or people mentioned in Indiana Lawyer editorial content are also subject to removal. Please respect the privacy of individuals and refrain from posting personal information.
 
No solicitations, spamming or advertisements are allowed. Readers may post links to other informational websites that are relevant to the topic at hand, but please do not link to objectionable material.
 
We may remove messages that are unrelated to the topic, encourage illegal activity, use all capital letters or are unreadable.
 

Messages that are flagged by readers as objectionable will be reviewed and may or may not be removed. Please do not flag a post simply because you disagree with it.

Sponsored by

facebook - twitter on Facebook & Twitter

Indiana State Bar Association

Indianapolis Bar Association

Evansville Bar Association

Allen County Bar Association

Indiana Lawyer on Facebook

facebook
ADVERTISEMENT
Subscribe to Indiana Lawyer
  1. So that none are misinformed by my posting wihtout a non de plume here, please allow me to state that I am NOT an Indiana licensed attorney, although I am an Indiana resident approved to practice law and represent clients in Indiana's fed court of Nth Dist and before the 7th circuit. I remain licensed in KS, since 1996, no discipline. This must be clarified since the IN court records will reveal that I did sit for and pass the Indiana bar last February. Yet be not confused by the fact that I was so allowed to be tested .... I am not, to be clear in the service of my duty to be absolutely candid about this, I AM NOT a member of the Indiana bar, and might never be so licensed given my unrepented from errors of thought documented in this opinion, at fn2, which likely supports Mr Smith's initial post in this thread: http://caselaw.findlaw.com/us-7th-circuit/1592921.html

  2. When I served the State of Kansas as Deputy AG over Consumer Protection & Antitrust for four years, supervising 20 special agents and assistant attorneys general (back before the IBLE denied me the right to practice law in Indiana for not having the right stuff and pretty much crushed my legal career) we had a saying around the office: Resist the lure of the ring!!! It was a take off on Tolkiem, the idea that absolute power (I signed investigative subpoenas as a judge would in many other contexts, no need to show probable cause)could corrupt absolutely. We feared that we would overreach constitutional limits if not reminded, over and over, to be mindful to not do so. Our approach in so challenging one another was Madisonian, as the following quotes from the Father of our Constitution reveal: The essence of Government is power; and power, lodged as it must be in human hands, will ever be liable to abuse. We are right to take alarm at the first experiment upon our liberties. I believe there are more instances of the abridgement of freedom of the people by gradual and silent encroachments by those in power than by violent and sudden usurpations. Liberty may be endangered by the abuse of liberty, but also by the abuse of power. All men having power ought to be mistrusted. -- James Madison, Federalist Papers and other sources: http://www.constitution.org/jm/jm_quotes.htm RESIST THE LURE OF THE RING ALL YE WITH POLITICAL OR JUDICIAL POWER!

  3. My dear Mr Smith, I respect your opinions and much enjoy your posts here. We do differ on our view of the benefits and viability of the American Experiment in Ordered Liberty. While I do agree that it could be better, and that your points in criticism are well taken, Utopia does indeed mean nowhere. I think Madison, Jefferson, Adams and company got it about as good as it gets in a fallen post-Enlightenment social order. That said, a constitution only protects the citizens if it is followed. We currently have a bevy of public officials and judicial agents who believe that their subjectivism, their personal ideology, their elitist fears and concerns and cause celebs trump the constitutions of our forefathers. This is most troubling. More to follow in the next post on that subject.

  4. Yep I am not Bryan Brown. Bryan you appear to be a bigger believer in the Constitution than I am. Were I still a big believer then I might be using my real name like you. Personally, I am no longer a fan of secularism. I favor the confessional state. In religious mattes, it seems to me that social diversity is chaos and conflict, while uniformity is order and peace.... secularism has been imposed by America on other nations now by force and that has not exactly worked out very well.... I think the American historical experiment with disestablishmentarianism is withering on the vine before our eyes..... Since I do not know if that is OK for an officially licensed lawyer to say, I keep the nom de plume.

  5. I am compelled to announce that I am not posting under any Smith monikers here. That said, the post below does have a certain ring to it that sounds familiar to me: http://www.catholicnewworld.com/cnwonline/2014/0907/cardinal.aspx

ADVERTISEMENT