Earn 5% — Even If the World Economy Merely “Muddles Through”
July 08, 2015 – by Richard Band
Greece’s woes, and now Puerto Rico’s threatened debt default, remind us that the global economy remains delicate — eight long years after the onset of the financial crisis.
But are conditions quite as bad as certain shrill commentators seem to think?
Over in the bond market, a fierce competition is taking place to see who can paint the direst scenario. On one side are the folks who warn of sharply rising interest rates, which would wreck the prices of Treasuries, municipals and other high-grade bonds.
On the other side is the deflationist crowd, arguing that a recession lurks just around the corner. A slumping economy, these gurus maintain, will usher in a wave of defaults among lower-grade bond issuers.
Both groups can’t be right, at least not at the same time — and there’s a good chance both will prove wrong.
In fact, my baseline scenario is that the world economy will muddle through, for another year or so anyway, led by slow but steady growth in the United States and pockets of strength elsewhere. I’m prepared to change course if the evidence shifts, but so far it hasn’t.
If “muddle through” prevails, Treasury yields will rise less than the consensus expects, while increased investor confidence in the economy will allow yield spreads on lower-grade paper to narrow somewhat from today’s levels. (The “spread” is the extra yield bond buyers demand over the Treasury yield to compensate for the risk that a lower-grade credit might default.)
Where can we, as fixed-income investors, make money in this environment?
The best opportunity, I believe, is in lower-grade corporate IOUs — paper rated below “investment grade” but not the junkiest of the junk. Yields here are higher than you can earn on Treasury debt of the same maturity. If the yield spread contracts, you may be able to pocket a capital gain, too (from rising bond prices).
During the first half of 2015, despite a negative total return of more than 5% for a typical long-dated Treasury bond, PONDX gained 2.8%. That was better than the stock market (S&P 500 up 1.2%), and better than 95% of the fund’s rivals in Morningstar’s multisector bond space — a stellar performance.
Portfolio manager Dan Ivascyn is no one-trick wonder, either — over the last five years, he has beaten a staggering 97% of the competition.
PONDX currently yields 5% based on the past three monthly distributions.
Outside the model portfolio, I’ve recommended a number of closed-end bond funds for investors who seek higher yields and can tolerate greater price swings than would be normal for an open-end fund like PONDX. In recent weeks, investors who fear either drastic Fed tightening or a deflationary recession have indiscriminately dumped closed-end bond funds.
As a result, many of these funds are trading at bargain prices.
A couple of closed-end funds I’ve recently looked at include Babson Capital Global Short Duration High Yield Fund (NYSE:BGH), which yields 10.1%, and FS Investment Corp. (NYSE:FSIC), which yields 8.9%.
You can check out my Profitable Investing service to learn more about these funds, as well as updates on other closed-end bond funds and, of course, other recommendations.
Richard Band’s Profitable Investing advisory service helps retirement savers outperform the market without losing a minute of sleep along the way. His straightforward style and low-risk value approach has won seven Best Financial Advisory awards from the Newsletter and Electronic Publishers Foundation.