| BUSINESSWEEK ONLINE : JUNE 26, 2000 ISSUE | ||||||||
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| COVER STORY
Bonds Step into the Limelight They're outperforming equities, and with less risk Albert Slawsky's mother-in-law faced an interesting challenge in 1992. The bulk of her investment portfolio consisted of cash and money-market funds. Luckily, her son-in-law--a senior vice-president at Chase & MDSass Partners, a New York money-management firm with $17 billion in short-term fixed-income investments--gave her some free advice: ''I told her for the next two years, on the last day of every month, you're going to take 2% of your assets and buy two-year Treasury notes issued on that day.'' He also suggested that she put 2% of her assets each month into equities in a broad market-index fund. The results have delighted Slawsky's mother-in-law: Her index fund tripled, and her bonds provided a steady income. But these days, she has become increasingly worried about stock- market volatility and a potentially slowing economy. For her, and other jittery investors, Slawsky's advice about two-year Treasuries still holds true. But she'll also find that there's a whole host of other defensive plays in the fixed-income market. ''While bonds are traditionally thought of as slow and boring, these days fixed-income offers a lot more sizzle, and still with a lot less risk,'' says Steven D. Artzi, president of Artzi Capital Management, an investment adviser in Boca Raton, Fla. Indeed, the bond market has outperformed equities so far this year. Through June 9, the Merrill Lynch Domestic Master Bond Index (which includes most U.S. investment-grade bonds) had a total return of 3.3%. By contrast, the Standard & Poor's 500-stock index had a total negative return of 0.32%. Among Treasuries, two-year notes now offer loftier yields than any other maturity. That's a result of two simultaneous trends: hikes in short-term interest rates by the Federal Reserve Board, and the U.S. Treasury's repurchase of longer-term bonds, which has reduced the supply of those bonds and increased their prices. (Yields move in the opposite direction of bond prices.) Indeed, for the first time since 1989, two-year notes are yielding more than 10-year bonds. As of June 9, for example, 10-year Treasury bonds yielded 6.13%, while the two-year notes yielded 6.54%--their highest since 1997. With the consumer price index up only 3% over the past 12 months, a 6.5% return is unquestionably attractive. ''The two-year Treasury note is a no-brainer,'' says Slawsky. ''It's an obvious investment choice.'' TIME BOMBS. If you are in a high tax bracket, however, you might also want to take a serious look at municipal bonds. ''Triple-A insured municipal bonds are still attractively priced,'' says John Lonski, chief economist at Moody's Investors Services in New York. Plus, with only slightly more credit risk, they can offer higher aftertax returns than Treasuries. But the two-year munis, unlike their counterparts in Treasuries, have lower yields than their longer-term brethren. For instance, a AAA-rated two-year muni, such as Quaboag Regional School District in Massachusetts, yields 4.7%, while the five-year from the same issuer yields 4.95%, and the 10-year version yields 5.2%. Still, experts say, investors should stay in the two- to five-year range, even though longer-term munis may look tempting. The reason: While a 10-year municipal offers 25 basis points (or hundredths of a percentage point) more yield than its five-year sibling, the risk is much greater. If interest rates rise, the price of the 10-year will drop 75% more than the price of the five-year, and three times as much as that of the two-year bond. With interest rates higher than they've been in the past two years, investing in government-backed mortgage securities is also an excellent idea. Ginnie Mae, Fannie Mae, and Freddie Mac issues now yield more relative to Treasuries than they have in many years. As interest rates have risen, fewer people are refinancing their mortgages. That means investors in mortgage-backed securities are likely to earn these higher yields for a longer time because fewer bonds will be redeemed early. For example, a Fannie Mae issue with an 8% coupon and a 2.2-year average life yields 7.69%, or nearly a fifth more than the two-year Treasury note. ''That's a lot of juice,'' says Slawsky. INFLATION-BUSTER. While some investors try to guess how interest-rate moves will affect their bond holdings, others are more concerned about how inflation could erode their retirement savings. If that's the case, experts suggest a fixed-income instrument called Treasury Inflation-Indexed Securities, nicknamed TIPS for short. ''There's lots of these guys issued. There are $200 billion of them owned; they're not like freaks of nature,'' says William H. Gross, managing director at Newport Beach (Calif.)-based PIMCO Advisors Holdings LP, which manages $300 billion in bonds. TIPS are bonds whose principal is tied to the consumer price index. That means the higher inflation gets, the more you get back. ''This is the ideal defensive investment because the proceeds at maturity will enable you to achieve your targeted standard of living without worrying about cost-of-living fluctuations,'' Gross says. If inflation averages 3%, a TIPS bought for $100 will grow to $134 in 10 years. Plus, with a current yield of 4%, interest would add another $50, to give a total return of 7.12%--almost a percentage point more than a 10-year Treasury bond. TIPS can be bought through the Treasury, brokers, and some mutual funds, such as the PIMCO Real Return Bond Fund. Corporate bonds, with yields in the 7.25% to 8.5% range, look alluring. Moody's Lonski, however, advises investors to steer clear of these bonds for now. In recent years, the securities have suffered many credit-rating downgrades, which cause their prices to fall. Warns Lonski: ''With investment-grade issues, you have to worry about the possibility of event-driven rating downgrades that might stem from equity buybacks, merger-and-acquisition activity, or leveraged buyouts.'' PROMISING. Others, though, think corporate bonds still have a place in conservative portfolios--even though their prices have lagged relative to Treasuries so far this year. These analysts argue that it's just a matter of time before corporate bonds once again outperform Treasuries. Besides, during the wait, corporate bonds continue to pay more interest. ''This additional income may compensate investors for the added risk,'' says Marc Seidner, associate director of Standish, Ayer & Wood in Boston, which manages more than $40 billion in fixed-income investments. ''We think there's incredible value in high-quality debt issued by U.S. corporations.'' Seidner cites Ford Motor Co. as a promising corporate-bond buy. On June 7, the company's Ford Motor Credit unit issued $2.5 billion-worth of 10-year bonds yielding about 1.8 percentage points more than 10-year Treasuries. ''The risk is that Ford might be unable to meet its obligations, which we don't think is a high risk,'' he says. Another choice is a Morgan Stanley Dean Witter Co. five-year bond issued on June 6, yielding 7.75%, or 1.38% more than the five-year Treasury. ''As with Ford,'' says Seidner, ''we don't anticipate that Morgan Stanley will have any trouble meeting its obligations.'' For sure, there's plenty of choice out there. Whether it's a question of preferring corporate bonds, government bonds, or munis, there's something that can help even the most risk-averse investor sleep soundly at night. By DEBRA SPARKS _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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 RELATED ITEMS Bonds Step into the Limelight TABLE: Best Buys in Bonds For the Record: Albert Slawsky INTERACT E-Mail to Business Week Online | |||
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