These are the halcyon days of cash. Money market funds and Treasury bills offer returns around 5% with virtually no credit or interest rate risk. Longer-maturity Treasuries yield less than short-maturity Treasuries, a condition known as an inverted yield curve, so there is no direct benefit to later maturities. In addition, the yield curve inversion is a remarkably prescient harbinger of a future recession, making corporate bonds unattractive.
But while cash may seem perfect now, it carries longer-term risks. Michael Arone, an investment strategist at State Street Global Advisors, points to the specter of reinvestment risk, or the danger that when interest rates eventually fall, money investors will have to reinvest at lower rates. He recommends a barbell approach, being overweight in cash on the one hand and longer-term high-quality securities on the other. “Now you can buy investment-grade assets with significant returns to offset some of that reinvestment risk,” he says.
Another plus: when the impact of the Federal Reserve rate hikes inevitably leads to a slower US economy, yields will fall, and if you own a few intermediate securities, you can participate in the uptrend as those securities rise in price . “If you stay in cash, you miss out on potential bond market rallies in the coming year,” said Dhruv Nagrath, director of fixed income strategy at BlackRock.
That message may now fall on deaf ears. Bond prices fell in July as interest rates rose sharply. 10-year Treasuries rose above 4% last Thursday for the first time since March. Inflation remains high and another Fed rate hike is expected this month. An exchange-traded fund that tracks a broad bond benchmark,
iShares Core US Aggregate Bond
(ticker: AGG), is down about 3% over the past three months.
Nevertheless, long-term investors, especially retirees looking for steady income, should prepare now for an eventual spike in returns and add some longer-maturity securities.
The good news: You can get a little more return than cash and still stay in high-quality securities if you look into less obvious corners of the fixed income markets. Preferred stocks, often issued by large, highly rated banks, yield about 6%. Similarly, agency mortgage-backed securities have little credit risk or prepayment risk because many homeowners stick with their 3% mortgages.
“Preferreds offer an interesting opportunity in an investment grade asset with returns in excess of 6%,” said Arone. They are also relatively cheap due to the regional banking crisis in March. “Rarely is there such a big discount for preferences,” he notes. State Street’s offering is the
SPDR ICE preferred securities
ETF (PSK), which yields 5.72%.
Cliff Corso, chief investment officer at Advisors Asset Management, likes short-term preferences issued by major banks and energy companies. From his firm
AAM Low Maturity Preferred & Income Securities
ETF (PFLD) yields almost 7%.
Nagrath has other high-quality securities on his list, including longer-term government bonds. “The recession will creep into the story,” he says. “It’s wise to have longer-dated Treasuries.” He suggests that investors add an ETF that tracks a bond benchmark, such as iShares’ Core Bond offering, which has an intermediate maturity and yields 4.12%.
Inflation-protected government bonds, agency MBS and emerging market local currency debt are also now in BlackRock’s fixed income playbook. Nagrath is less of a fan of preferences due to their exposure to the financial sector. The
iShares preferred and income securities
ETF (PFF) offers a return of 6.62%, but 70% of the assets are in banking preferences. Yet it is difficult to argue against a modest allocation to that sector. B
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