In Search Of Fixed Income (MUB, LQD, HYG, TIP, JNK)

Russ Koesterich: Call #1: Reiterate Long-Term Overweight of Corporate and Municipal Debt Over Treasuries

In today’s low rate environment, many investors are looking for fixed income opportunities. As I’ve discussed in the past, for long-term investors, I favor corporate and municipal bonds over Treasuries.

Here are two reasons why I like corporate debt:

  • Yield: Corporate bonds currently offer a rich yield relative to US Treasuries. Today, the spread between an index of Moody’s Baa-rated bonds and the 10-Year Treasury is 330 basis points, roughly twice the sixty-year average.
  • Strong Balance Sheets: At the same time that corporate yields are high relative to Treasuries, corporate America’s balance sheet looks exceptionally strong. US companies are holding more than $2 trillion in cash, which represents roughly 7% of company assets and the highest level since 1963.

Here are also two reasons why I like munis.

  • Yield: First, similar to corporate bonds, municipals currently provide a rich, after-tax yield versus Treasuries of a similar duration. An index of national long duration GO bonds is yielding roughly 3.8%. On a tax adjusted basis, that’s roughly equivalent to a 6% yield for a theoretical taxpayer in the 35% bracket.
  • Unfounded Dire Predictions: Plus, while munis potentially offer investors a significant pickup in yield, I don’t believe investors in munis are taking on much more risk.  As I’ve stated in the past, some of the more dire predictions for munis have turned out to be unfounded. Last December, we all heard predictions that 2011 would see hundreds of billions of dollars in defaults. Year-to-date, municipal defaults are running at less than $1 billion.

While both municipals and corporate bonds look cheap, by most accounts Treasuries look very expensive. While I hold a neutral view of Treasuries in the near term, I hold a negative longer-term view of Treasuries. Unless you believe that the United States is about to, or has already, entered a Japanese-style deflationary spiral, it is hard to justify accepting a 2% nominal yield and a negative after-inflation yield while taking on significant duration risk. [Potential iShares solutions: iShares S&P National AMT-Free Muni Bond ETF (NYSE:MUB) and iShares iBoxx $ Invest Grade Corp Bond ETF (NYSE:LQD)].

Disclosure: Author is long MUB and LQD

Source: Bloomberg

Past performance does not guarantee future results.

Bonds and bond funds will decrease in value as interest rates rise.  A portion of a municipal bond fund’s income may be subject to federal or state income taxes or the alternative minimum tax. Capital gains, if any, are subject to capital gains tax. Federal or state changes in income or alternative minimum tax rates or in the tax treatment of municipal bonds may make them less attractive as investments and cause them to lose value. An investment in the Fund(s) is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency.

Written By Russ Koesterich From The iShares Blog

Russ Koesterich, CFA, is the iShares Global Chief Investment  Strategist as well as the Global Head of Investment Strategy for  BlackRock Scientific Active Equities. Russ initially joined the firm  (originally Barclays Global Investors) in 2005 as a Senior Portfolio  Manager in the US Market Neutral Group. Prior to joining BGI, Russ  managed several research groups focused on quantitative and top down  strategy. Russ began his career at Instinet in New York, where he  occupied several positions in research, including Director of Investment  Strategy for both US and European research. In addition, Russ served as  Chief North American Strategist for State Street Bank in Boston.

Russ holds a JD from Boston College Law School, an MBA from Columbia Business School, and is a holder of the CFA designation. He is also a frequent  contributor to the Wall Street Journal, New York Times, Associated  Press, as well as CNBC and Bloomberg Television. In 2008, Russ published  “The ETF Strategist”(Portfolio Books) focusing on using exchange traded  funds to manage risk and return within a portfolio.

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