Stand By Your Bonds

Income Investing

Stand By Your Bonds

I’d be scared if I thought that interest rates would shoot up across the board and that the creditworthiness of borrowers is wilting. But I just don’t see it.

Getty Images

I'm expecting another good year for bond and bond-style investments in 2020. Not as spectacular as 2019, but rewarding enough to feel confident about sticking with what's working.

SEE ALSO: The 7 Best Bond Funds for Retirement Savers in 2020

A year ago, my plea to stand by your bonds in 2019 appeared stubborn if not reckless. Late in 2018, long-term Treasury and other interest rates were surging (with prices moving in the opposite direction), the Federal Reserve was tightening short-term credit, and economic growth was running closer to 3% than the tame 2% that's the sweet spot for fixed-income portfolio returns. Popular and expertly managed funds such as Baird Aggregate Bond, Dodge & Cox Income, Loomis Sayles Bond and Vanguard Total Bond Market finished 2018 with rare and unexpected losses—slim, bearable ones, but losses nonetheless—while banks were ratcheting rates on insured savings accounts to beyond 2% with the Fed as their partner.

But my reasons for ignoring the naysayers in 2019 remain the same for 2020. Extended bull markets don't go over a cliff. They transition and wither away over months, often years. I'd be scared if I thought that U.S. interest rates are finally set to shoot up across the board and that the creditworthiness of borrowers is wilting. But I just don't see it. The globalized “lower for longer” rate argument I've embraced for 10 years lives on.

Where to reach for yield. That means it's safe and effective to stretch for yield, whether with high-dividend stocks, such as AT&T and real estate investment trusts, or with high-interest, BBB-rated corporate bonds, municipals and preferred stocks. (Technically, preferreds pay dividends, but as a practical matter they are senior fixed-rate debt.)

Advertisement

The headache for income investors in 2020 is not likely to come from accelerating losses, but from the challenge of finding fewer worthy choices for new investments. Rates are low—but remember, most of the rest of the world is dealing with negative yields.

Investors can still find fresh high-yield (so-called junk) bonds yielding 4% and bank preferreds delivering 4.75%. Knee-jerk thinking holds that such yields are risky and a sign that the end of the boom is nigh. My in­terpretation is that Toll Brothers, Fifth Third Bank and the like have no trouble placing such borrowings, and if you happen to be one of their investors, you'll get paid in full and on time.

Fixed-income fundamentals are still positive, says Doug Baker, who manages various closed-end funds for Nuveen, including Nuveen Preferred and Income Term Fund (symbol JPI), which has a 2019 total return through October 31 of 30.7%. Baker says tight or tighter bond supplies, continuing high demand and constant refinancing of higher-rate debt are all positives.

Risk is mainly sector-specific. An indicator called the junk-bond distress ratio is at a three-year high. But exclude energy and the ratio (the proportion of junk bonds trading at inflated interest-rate spreads over Treasuries) falls below where it ended 2018. The average junk fund returned over 10% in 2019. Don't count on a 10% return again in 2020, but don't rule it out.

Advertisement

This happy talk doesn't mean to abandon all discipline. A rule of thumb is to look for bonds or funds with a yield that is greater than their duration, which measures interest-rate sensitivity. The lower the duration, the smaller the loss if rates rise. Osterweis Strategic Income (OSTIX) and PGIM Short Duration High Yield (HYSAX) both have durations of less than 2, yields pushing 4% to 5%, and long records of success. I also think tax-exempt bonds will continue to rock the world in 2020—more on munis in a future column.

SEE ALSO: 10 Dividend Aristocrats Expected to Deliver Big Gains in 2020