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Confronting shrinking interest rates

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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.

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  1. Call it unauthorized law if you must, a regulatory wrong, but it was fraud and theft well beyond that, a seeming crime! "In three specific cases, the hearing officer found that Westerfield did little to no work for her clients but only issued a partial refund or no refund at all." That is theft by deception, folks. "In its decision to suspend Westerfield, the Supreme Court noted that she already had a long disciplinary history dating back to 1996 and had previously been suspended in 2004 and indefinitely suspended in 2005. She was reinstated in 2009 after finally giving the commission a response to the grievance for which she was suspended in 2004." WOW -- was the Indiana Supreme Court complicit in her fraud? Talk about being on notice of a real bad actor .... "Further, the justices noted that during her testimony, Westerfield was “disingenuous and evasive” about her relationship with Tope and attempted to distance herself from him. They also wrote that other aggravating factors existed in Westerfield’s case, such as her lack of remorse." WOW, and yet she only got 18 months on the bench, and if she shows up and cries for them in a year and a half, and pays money to JLAP for group therapy ... back in to ride roughshod over hapless clients (or are they "marks") once again! Aint Hoosier lawyering a great money making adventure!!! Just live for the bucks, even if filthy lucre, and come out a-ok. ME on the other hand??? Lifetime banishment for blowing the whistle on unconstitutional governance. Yes, had I ripped off clients or had ANY disciplinary history for doing that I would have fared better, most likely, as that it would have revealed me motivated by Mammon and not Faith. Check it out if you doubt my reading of this, compare and contrast the above 18 months with my lifetime banishment from court, see appendix for Bar Examiners report which the ISC adopted without substantive review: https://www.scribd.com/doc/299040839/2016Petitionforcert-to-SCOTUS

  2. Wow, over a quarter million dollars? That is a a lot of commissary money! Over what time frame? Years I would guess. Anyone ever try to blow the whistle? Probably not, since most Hoosiers who take notice of such things realize that Hoosier whistleblowers are almost always pilloried. If someone did blow the whistle, they were likely fired. The persecution of whistleblowers is a sure sign of far too much government corruption. Details of my own personal experience at the top of Hoosier governance available upon request ... maybe a "fake news" media outlet will have the courage to tell the stories of Hoosier whistleblowers that the "real" Hoosier media (cough) will not deign to touch. (They are part of the problem.)

  3. So if I am reading it right, only if and when African American college students agree to receive checks labeling them as "Negroes" do they receive aid from the UNCF or the Quaker's Educational Fund? In other words, to borrow from the Indiana Appellate Court, "the [nonprofit] supposed to be [their] advocate, refers to [students] in a racially offensive manner. While there is no evidence that [the nonprofits] intended harm to [African American students], the harm was nonetheless inflicted. [Black students are] presented to [academia and future employers] in a racially offensive manner. For these reasons, [such] performance [is] deficient and also prejudice[ial]." Maybe even DEPLORABLE???

  4. I'm the poor soul who spent over 10 years in prison with many many other prisoners trying to kill me for being charged with a sex offense THAT I DID NOT COMMIT i was in jail for a battery charge for helping a friend leave a boyfriend who beat her I've been saying for over 28 years that i did not and would never hurt a child like that mine or anybody's child but NOBODY wants to believe that i might not be guilty of this horrible crime or think that when i say that ALL the paperwork concerning my conviction has strangely DISAPPEARED or even when the long beach judge re-sentenced me over 14 months on a already filed plea bargain out of another districts court then had it filed under a fake name so i could not find while trying to fight my conviction on appeal in a nut shell people are ALWAYS quick to believe the worst about some one well I DID NOT HURT ANY CHILD EVER IN MY LIFE AND HAVE SAID THIS FOR ALMOST 30 YEARS please if anybody can me get some kind of justice it would be greatly appreciated respectfully written wrongly accused Brian Valenti

  5. A high ranking Indiana supreme Court operative caught red handed leading a group using the uber offensive N word! She must denounce or be denounced! (Or not since she is an insider ... rules do not apply to them). Evidence here: http://m.indianacompanies.us/friends-educational-fund-for-negroes.364110.company.v2#top_info

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