#3 What Worked in 2012

by Wayne Ferbert on January 16th, 2013

#3 What Worked in 2012 - Fixed Income Investing

If you had any fixed income in your portfolio in 2012, you should have been fairly satisfied with the returns from that portion of your portfolio. In fact, on a risk-adjusted basis, you should have been VERY satisfied.
 
In 2012, not only did you clip a coupon every period from your fixed income position, but this asset class had very nice price appreciation also. Interest rates continued to decline in 2012 and this drove the price of fixed income up.
 
If you follow us on BuyAndHedge.com, then you know that we like to use two ETFs for our controlled exposure to fixed income: symbol LQD for Investment Grade and JNK for High Yield Bonds. If you track just the price appreciation on these ETFs, it was significant for the fixed income category.
 
LQD’s price was up 6.4% for the year and paid another 3.7% in dividends during the year. No one looked back on 2012 and complained about a total 10% return in investment grade fixed income. Think about that? These are low risk bonds in highly rated companies. There were few if any credit problems within this class of company in 2012. So, on a risk-adjusted basis, these returns were exemplary.
 
JNK’s price was up 5.9% for the year and it pays a more handsome dividend clocking in at 6.6% in 2012. The high yield category is more risky so it pays a nicer dividend. But really in 2012, there were not many high profile defaults in this category and the broad category held up well. Even with the additional risk of being in this category, the total returns exceeded 12%.
 
More than likely, your individual fixed income positions held up unless your advisor happened to put your money in to one of those rare defaults in 2012. So, whether you were using fixed income for retirement spending or just diversifying a portfolio, this asset class came thru for you in an unexpected way in 2012.
 
Why do we see these returns as unexpected in 2012? The price appreciation was really unexpected at these levels. Many prognosticators predicted going in to 2012 that the interest rate trade needed to turn back the other way. Or, at the very least that interest rates couldn’t go any lower. But they did and the resulting price appreciation was a gift for investors.
 
The big question now: can the fixed income category hold these gains in 2013? In the end, your interest rate hypothesis will have the most say in whether that occurs. Again, for the 3rd year in a row, many prognosticators predict that interest rates have to start rebounding in 2013. We’ll see. That would certainly be the catalyst for a price pull back.

We aren't betting on an interest rate increase that would cause a material price pull back. However, we don't expect any further price appreciation really. We just think the interest rate trade is a likely 2014 proposition. No one ever lost money taking some profit off the table. In this category, that is worth some consideration.




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