Individual Bond Choice Matters

Doug Drabik discusses fixed income market conditions and offers insight for bond investors.

Many investors buy individual bonds as a means to preserve their wealth. They can serve as a method to balance growth assets (such as stocks). We’ve talked a lot about how interest rates are currently elevated and how buying individual bonds provides investors with relatively high levels of income and potential cash flow - levels not readily obtainable over the last 15 years. Now if that is not enough, in addition to the current income benefits, market conditions may be favorable for positive total returns. Total returns take into consideration the income as well as the price appreciation/depreciation on an asset. Many investors buy individual bonds to hold to maturity which removes price effects on return. Since most pundits and investors are anticipating interest rates dropping, price appreciation would be a positive consequence of falling interest rates for total return investors.

 Curve Comparisons

All of this creates a valid awareness to lock into these yields for longer. Increasing duration is a compelling long-term strategy. The choice of individual bonds can be optimized by viewing what the various product curves offer. When the media talks about the “curve,” it typically means the Treasury curve (purple line). The corporate (blue) and municipal (black) bond curves maintain very different shapes and can help guide investors to bonds that will optimize returns.

This graph contains only high-quality investment-grade level credits. The corporate curve is fairly flat yet elevated. It creates much opportunity in the short to intermediate maturity range. The municipal curve is the steepest most upward-sloping of the curves, but very expensive on the short-to-intermediate part of the curve. The greatest value for municipals is in the 15-30 year range. It also is based on investors in the highest federal tax bracket where the tax-free income benefits realized are at their greatest. If you are an investor in any of the lower federal tax brackets, the after-tax equivalent yields would be lower than depicted.