July 2010
Ask a trust officer:
Bonds
DEAR TRUST OFFICER:
How much of my portfolio should be in
bonds? A lot more than a couple years
ago? —AVERSE TO VOLATILITY
DEAR AVERSE:
Given the wrenching losses
in global equity markets of the last few years, a flight by investors to the
lower volatility and higher predictability of bonds is to be expected. Perhaps
“stampede” would be a better description than “flight.” According to Morningstar Advisor, open-ended bond
funds in the U.S. took in $357 billion in 2009, more than all other asset
classes combined and more than the previous five years combined.
Strong demand for bonds,
coupled with the Federal Reserve’s policy of keeping interest rates low to
stimulate the economy, have pushed yields to very low levels. It takes a lot of
capital to get much income if aggregate yield is hovering at 3.5%.
Beyond the difficulty of
generating income, bond investors have to worry about how the economy will
affect the value of their holdings.
Should the economy falter,
state and local tax revenues won’t be growing—and could be falling—at a time of
increasing demand for state services. Unfunded public employee pension
obligations are another storm cloud in this area. These factors could increase
the default risk of muni bonds, depressing prices. On the other hand, rising
tax rates in the future could increase the demand for tax-free income. Coupled
with a supply shortage resulting from the advent of taxable Build America Bonds
for state and local governments to issue, there is some built-in future price
support.
Strong economic growth won’t
be unalloyed good news for bond investors either. Once growth becomes robust,
the Fed is certain to let interest rates rise back to normal levels. That would
push bond prices down, with the biggest declines expected for the longest
maturities.
If you are concerned about the role bonds are playing
in your portfolio, we invite you to come in to speak with our investment
professionals.
Do you have
a question concerning wealth management or trusts? Send your inquiry to tormey@pgbank.com
(July 2010)
© 2010 M.A. Co. All rights reserved.