Last week two members of The Joseph Group’s investment team, Travis Upton and Aaron Filbeck, were in Denver, Colorado meeting with fund managers at the Westcore Funds. Westcore manages mutual funds and institutional accounts in a wide range of strategies including small company growth stocks, dividend paying stocks, corporate bonds, and international small company stocks. Travis and Aaron had the opportunity to discuss markets and strategy with all of the different fund management teams and gain valuable insights for The Joseph Group’s investment committee.
One notable presentation was given by Westcore’s Director of Fixed Income Research, Troy Johnson, and Fixed Income Portfolio Manager and Credit Analyst, Greg Shea. Here are a few takeways from their discussion:
- There is still value in corporate bonds. According to Johnson, there are a number of reasons to be positive on overall financial markets including unemployment at a cycle low, rising wages for US workers, and signs of economic improvement spreading beyond the U.S. and into Europe and the emerging markets. In the bond market, these positives imply there is still value in both high and low quality corporate bonds which provide higher rates of income than government bonds.
- Income can be an important buffer against rising interest rates. Interest rates and bond prices have a relationship like a teeter-totter – when interest rates go up, the other end of the teeter-totter, bond prices, goes down and vice versa. For investors who are concerned about rising rates negatively impacting their bond portfolios, Johnson noted that an approach focusing on income from bonds carries certain offsets in a rising rate environment. Investors who are concerned about the impact of rising rates generally reference government bonds as a proxy for market interest rates. However, Johnson notes bonds which pay a higher rate of income, (i.e., corporate bonds), move differently than Treasury bonds and may provide a cushion against interest rate risk. Two primary factors which are likely to increase interest rates, inflation and a stronger economy, are actually positive for corporate bonds. By combining corporate bonds with Treasuries in a high quality bond portfolio, not only is the overall income rate likely higher than Treasuries alone, but diversification effects result in a portfolio with less sensitivity to rising interest rates.
- Any rise in rates is likely to happen slowly. Despite the positives, Johnson noted this is not a time to be complacent and cited concerns including low productivity growth, a divided economy with income inequality, and the continued challenges of the political process. Under this backdrop, Johnson and Shea feel it is unlikely we see a sharp rise in interest rates anytime soon. They noted that so far in 2017, rates have been range bound. Today, the benchmark 10-year Treasury bond has an interest rate of 2.3%, which is more than 0.25% lower than the 2.6% rate seen shortly after President Trump’s election. Even if the Fed continues to increase short-term interest rates, any rise in longer-term rates (which influence things like mortgages) is likely to be gradual. If Johnson and Shea are correct, it implies investor fears of losing money in bonds due to rising interest rates may be overblown. It also implies investors who are seeking safety and diversification away from stocks may want to look to high quality intermediate bonds as opposed to cash.