November 1, 2008 — Investing during the last several weeks within an environment of rapidly declining asset values and record volatility has been more about damage control than implementing a pro-active strategy. Given the extent of recent market losses, most asset allocations have seen sweeping, dramatic changes and as a result investors are now faced with difficult portfolio rebalancing and tactical investment positioning decisions. While we support the investment notion of employing a periodic rebalancing policy for strategic allocations, we would caution against an aggressive move back into equities at this time. Even given the magnitude of the sell-off across the global equity markets, when one weighs the macro environment, relative asset valuations and the probable upside and downside market scenarios, we believe a stronger case can be made for significantly enlarging allocations to the fixed income sector, especially high-grade credit, for better returns versus equities over the next six to twelve months.
Tag: Market & Economic Commentary
Sage Advice Special Report 1Q2008
March 31, 2008 — Structured investment vehicles, or SIV’s for short, were created by offshore investment companies that sell short-term securities to purchase higher yielding long-term bonds and profit from the positive carry between the two. For SIV managers, longer dated securities such as mortgage backed and structured products were utilized to maximize the spread between the short and long positions. In turn, money market and short dated funds invested in the short dated paper sold by the SIV issuers due to the attractive yield relative to other short term products as well as its perceived safety and liquidity. The rise in market volatility that started at the beginning of 2007, shown below in the VIX chart, caused liquidity to quickly dry up and investors’ appetite for risk to suddenly wane.
Municipal Market Monitor
December 31, 2007 — The municipal market just experienced one of the most volatile quarters in recent history. With the repricing of risk that occurred in August due to issues within the mortgage and credit markets, municipals were inadvertently hammered down with the rest of the market. Leveraged players that utilized municipal securities were forced to unwind many of their deals due to the divergence in yield movements between the underlying securities and the hedging vehicle. In addition, liquidity concerns contributed to the lack of interest for municipal securities, which can be a common occurrence for Muni’s during economic turmoil. However, for the astute investor, these events have created great opportunities to invest in the municipal market at tax adjusted yield levels not seen since 2003.
A Curve for All Seasons — Taking Advantage of Municipal Bond Yield Curve Trend
September 30, 2007 — Traditionally, the shape of the Treasury yield curve has a positive slope; longer dated securities offer higher yields than shorter dated maturities. In normal market environments, this relationship applies to all yield curves such as the mortgage and corporate markets, where the yield spread over Treasuries increases for longer maturities. The main reason for higher yield or spread is to compensate the investor for the added risk of inflation and/or credit risk associated with the issuer. However, there have been times when the slope of the yield or credit curve has become flat or inverted. Typically, a negative yield curve (short rates higher than long rates) has been a precursor to an economic recession or slowdown. In this environment, a tight monetary policy and a flight to quality are a result of a projected slowdown in growth and inflation leading investors to accept a lower yield for longer dated securities. In contrast, the Municipal yield curve has been able to maintain a positive slope over time, in spite of the shifting shape of the Treasury yield curve.
Going Beyond Core Equity
March 1, 2007 — Adding alternative asset classes to a core equity portfolio as a risk diversifier and potential return enhancer is not a new concept, but it has become easier and more cost efficient to do so with the growth of index-based products. Specifically, Exchange-Traded Funds (ETFs) provide a liquid, transparent and cost effective way to gain exposure to many alternative asset classes. Further, ETFs allow investors to go beyond a static exposure by offering a vehicle that can be used to tactically manage that exposure.
Municipal Bond Portfolios: The Case for Active Management
October 1, 2006 — Why should investors employ active management for their municipal bond portfolio? This is a question posed by many individuals who want tax free income. Despite the perceived safety and stability of municipal bonds, active management can add incremental value.
Sage Advice Special Report — Tobacco Obligation Bonds
June 1, 2006 — Over the past 24 months, municipal bonds have had a stellar run relative to other asset classes on an after-tax and risk adjusted basis. In addition to the municipal market’s overall return, the tobacco obligation bond sector has experienced double digit returns, while other sectors have realized comparatively lower returns. This extraordinary performance, driven primarily by event risk, had a significant impact on the Lehman Municipal Long Bond Maturity Index’s return. In this short report, we examine the recent historical effects of tobacco obligation bonds on the Lehman Broad Municipal Index
Asset/Liability Monitor — Perfect Storms and Ticking Time Bombs
October 1, 2005 — Much has been written about the defined benefit pension plan (DB plan) crisis and how the “perfect storm” of falling interest rates mixed with falling equity asset values caused plans to shift from overfunded to underfunded status within a few years. This simplified explanation implies that higher interest rates (i.e. discount rates) and an improving stock market will naturally fix this problem and the underfunded status to evaporate. Unfortunately, saving DB plans and the threat to employee retirements will be much more difficult than simply raising discount rates or waiting for a cyclical market recovery. Billions of dollars have already been spent by corporations and billions more will inevitably be needed to overcome the growing underfunded pension void created by misguided investment strategies. The damage has been severe with even more danger on the horizon. Makeshift solutions can buy time, but long term structural change will be necessary to return stability to the pension system.
A Status Report on U.S. Pensions: The Savings and Loan Crisis Revisited?
June 1, 2005 — Recent events surrounding the current pension plan crisis are starting to look very similar to the early stages of the 1980’s savings and loan debacle. Legislative response to underfunded plans resembles the deregulation laws instituted to assist struggling S&Ls. Savings and Loan lobbyists imposed political pressure to encourage new laws aimed at aiding the struggling industry, but in the end, essentially increased the cost of the collapse. As with underfunded pension plans, interest rates were a major ingredient in the debacle. S&L insolvency, which had more to due to asset/liability mismatches on balance sheets, led to stopgap interim policies that lowered net worth requirements until interest rates corrected to “normal” levels. These policies were very similar to the discount rate adjustment provided in the Pension Funding Equity Act of 2004, wherein temporary relief is granted to underfunded plans until assets can grow and bring the plans back into funded status.
Sage Advice — Is Inflation Really This Tame?
September 1, 2004 — Inflation has always been at the forefront of the market’s consciousness and for good reason. Besides dictating real household spending power and real returns for investors, inflation plays a key role in monetary policy as maintaining price stability is one of the main objectives of the Federal Reserve. The focus on inflation indicators has been even greater the last year or so as market concerns have come full circle, from deflation concerns in early 2003 to worries about accelerating inflation in the second quarter of 2004. Much of the recent acceleration has been explained away as due to a spike in energy and food costs, which are stripped out of inflation indicators when reporting “core” inflation. Still there’s no denying we’ve seen a pick up in overall and core inflation over the last year, no matter which indicator you choose to look at.