Click Here to Print

Wednesday, August 15, 2018

MANAGING DIRECTOR:
Scott Carrithers
 
PORTFOLIO SALES AND SERVICE:
Steve Panknin • George Morris • Jeff Goble • Chris Thompson • Sean Doherty
Kevin Doyle • Lonnie Harris •  Mark Tranckino • Robert Schuyler • Tom Toburen • Josh Kiefer
 Nicole Burczyk • Kelley Frye • Natalie Regan • Aaron Stoffer • Chuck Honeywell • Gus Koppen

US Treasury Market
Date 1 mo 3 mo 6 mo 1 yr 2 yr 3 yr 5 yr 7 yr 10 yr 20 yr 30 yr
8/8/18 1.93 2.06 2.24 2.44 2.68 2.77 2.83 2.92 2.96 3.05 3.12
8/9/18 1.91 2.06 2.25 2.44 2.64 2.74 2.80 2.89 2.93 3.01 3.08
8/10/18 1.92 2.05 2.23 2.42 2.61 2.68 2.75 2.82 2.87 2.96 3.03
8/13/18 1.93 2.06 2.22 2.42 2.61 2.68 2.75 2.82 2.88 2.97 3.05
8/14/18 1.96 2.08 2.25 2.44 2.63 2.71 2.77 2.84 2.89 2.98 3.06
                                                                                                                                       Source: U.S. Department of the Treasury, as of 08/14/2018
 
Bond Laddering Works (too bad so many investors don’t understand why)
 
A professional investor was recently extolling the virtues of bond laddering (a tried and true bond portfolio management strategy).  She referred to laddering as a measure of portfolio immunization against dramatic price movement and compared it to dollar cost averaging.  This stands to reason…the short end of the ladder exhibits less price volatility than the long end and dollars are reinvested regularly.  Furthermore, laddering is shrewdly simple and cost efficient (ie: not prone to generate excess trading fees).

Too bad so many investors simply don’t appreciate the ladder’s charms.  Even the professionals get it wrong.  Leaving out names in order to protect the guilty, a nationally syndicated personal finance author cited the following six reasons bond ladders are bad for investors.   As you’ll see below, all six objections appear incorrect (and, in some instances, laugh-out-loud foolishly wrong).

INCORRECT ASSERTION #1: Bond Ladders Deprive Investors of Current Income.   Supposedly, bond fund investors will earn substantially more when interest rates rise because managers are buying, new, higher yielding bonds.
  • RESPONSE: Managers doing this will be selling existing bonds at losses, thus reducing par value (Net Asset Value).  So even if the average coupon rate is higher, the underlying par value is lower (due to realized losses).  This is not a text book method of increasing value or income.  It is, however, a well-practiced method of creating capital losses.
INCORRECT ASSERTION #2: Bond Ladders Often Force Investors to Reinvest at Lower Rates.   Supposedly, bond ladder investors won’t have sufficient funds (from coupons and maturities) to reinvest into another bond (I wonder if the author knows that US Treasuries can be purchased in lots as small as $1,000?).  This supposedly forces them to sit in low yielding cash money market funds until they amass more substantial balances for reinvestment.
  • RESPONSE: With uninterrupted regularity, bond maturities and coupons are very easily and efficiently reinvested into various stripes of fixed income.  It is as common as breathing.
INCORRECT ASSERTION #3: Bond Ladders Deprive Investors of Capital Gains.   This is a laugher!  The notion is bond funds which have invested in X, Y and Z bonds will have gains, those gains will be realized and NAV will move commensurately higher.  Yet somehow, laddering investors who also own X, Y and Z bonds won’t be likely to realize those gains.
  • RESPONSE: There’s no rule that prevents laddering investors from taking gains whenever desired.  Furthermore, even if laddering investors were somehow precluded from taking gains as desired, the enhanced value is STILL THERE (just not realized) and all the while the original, now higher than current market, coupon stream is still intact and earning at a pace above and beyond that which a fund investor could match.
INCORRECT ASSERTION #4: Bond Ladders Carry More Default Risk.   This statement is predicated on the notion that laddering investors won’t have sufficient funds to spread credit risk appropriately.  Whereas bond funds do have such largesse and will appropriately diversify.
  • RESPONSE: What’s the risk of default in a US Treasury?  Or US agency?  Or prerefunded muni?  Nunca, nein, none, zero.  Furthermore, the default rate in top quality, well known, plain vanilla GO muni bonds or essential purpose revenue bonds is far to the right of the decimal.
INCORRECT ASSERTION #5: Bond Ladders Leave Investors Unprepared for Emergencies.   So the author suggests bond mutual funds are ready cash, all the time.  Yet bonds in a ladder are not. 
  • RESPONSE: Wrong, wrong wrong…a thousand times wrong.  So the X, Y and Z bonds in the mutual fund can be sold anytime “without cost” but the X, Y and Z bonds in your own ladder cannot?  Really?!  This suggests the bond fund manager conjures a magic liquidation process that another bond owner cannot.  Furthermore, the author cites possible losses (due to higher rates, lower prices) that the laddered portfolio will be subject to.  Yet this is somehow not germane to the discussion when considering the fund.  Wrong, wrong, wrong. 
The reality of the matter is the laddered investor can liquidate a holding at any time with, very likely, the same market spreads that the fund manager would be subject to as well (markets with the highest liquidity and trading volume demonstrate this best).  And all the while the laddered portfolio is NOT PAYING A MANAGEMENT FEE for this privilege.

INCORRECT ASSERTION #6: Bond Ladders Are Expensive.   The author suggests the process of buying and constructing a ladder is more expensive because of market spreads and dealer markups.  Whereas a no-load fund merely has “small” management fees to pay each year.
  • RESPONSE: Again, our author is woefully unaware of market conventions which afford buyers of all shapes and sizes efficiencies which are not solely reserved for bond fund managers.  For instance, newly issued US agencies and certain corporate and municipal bonds will initially be offered “at syndicate pricing” to all comers.  Whether buying large lots or small lots, the pricing is the same (the greater challenge, for ALL varieties of investors, may be gaining access to the bonds).  And if US Treasuries are the topic, buyers of every inclination may acquire them at virtually no cost through the Fed in regularly scheduled single price auctions (aka: Dutch Auctions).  And again…no annual fee is paid for the mere honor of owning these fixed income delights.  Lastly, the author conveniently “forgets” that these same heralded no-load funds will often carry a Deferred Contingent Sales Charge (DCSC).  While these DCSCs will typically expire after five years, they are additional fees due and payable upon liquidation to the fund company.
Bottom Line: Laddering is as basic, pure and cherished in bond portfolio management as hot dogs, moms and apple pie are to the American spirit.  If you seek a no-drama “hit singles and get to the hall of fame” bond portfolio strategy, give yourself a leg up on a ladder.

Call your Country Club Bank Capital Markets representative for ideas and service.


This information is intended for institutional investors only. The material provided in this document/presentation is for informational purposes only and is intended solely for private use. Past performance is not indicative of future results. This material is not intended as an offer or solicitation for the purchase or sale of any financial instruments.

•Not FDIC Insured •No Bank Guarantee •May Lose Value