David Fabian: Almost no other category of investing has experienced as much turmoil in the last 12 months as income investors have been subjected to. Interest rates have been on a roller coaster ride that has churned the landscape for core themes in fixed-income, REITs, preferred stocks, and even dividend paying equities. Years of low volatility in many of these categories had lulled income seekers into a false sense of security that led to jolting changes in a short period of time.
Fortunately, we have seen stabilization in interest rates this year and fears of a stock market collapse have yet to materialize despite the best efforts of “top calling experts”. Now that we just closed out the first quarter, this is a perfect time to review your statements and assess the strengths and weaknesses of your portfolio. Through this analysis, you may find areas that can be adjusted to enhance your returns for the remainder of the year.
1. Lower your average fixed-income duration
You have probably heard the call to lower the average duration of your fixed-income holdings for some time now, but many investors are still finding themselves in the upper end of the yield curve. That makes your portfolio more sensitive to fluctuations in interest rates which could prove to be a mistake if we see rates move higher this year.
One alternative ETF that you may want to consider is the Vanguard Short-Term Corporate Bond Fund (NASDAQ:VCSH) which invests in a portfolio of 1-3 year duration investment grade fixed-income. This ETF has been steadily rising over the last six months and will be less sensitive to changes in interest rates than a similar fund with higher average duration. Another strategy to consider is moving to an actively managed mutual fund that is focused on interest rate risk and had success navigating those waters last year.
2. Resist high priced junk bonds
Domestic high yield bonds (otherwise known as junk bonds) have had a tremendous ride over the last several years. Low default rates and a thirst for yield have been tremendous drivers of asset prices in this sector. However, valuations have appeared to reach an extreme level which has in turn led to lower yields for new money being added to this space.
If you already own a junk bond ETF such as the iShares High Yield Corporate Bond ETF (NYSEARCA:HYG), I would continue to hang onto the position with the expectation that we may see a shift in credit at some point that would necessitate an exit from this holding. Prices are not indicating any kind of problem as of yet and the income streams are still solid for early adopters. However, there will come a time when it will make sense to switch to higher credit quality areas such as investment grade corporate bonds or mortgage securities.
One possible alternative that I believe is offering a more attractive value proposition with a comparable yield is the iShares JP Morgan USD Emerging Market Bond ETF (NYSEARCA:EMB). This ETF sports a yield of just under 5% and is still trading below its 2013 highs.