Tag Archives: Brooks Hughes Jones

High-yield bonds may not be junk

Posted on October 27, 2011 | Leave a comment

High-yield corporate bonds have built a big edge in income yield over Treasury bonds over the past few months. Some people prefer the perceived safety of Treasury bonds and accept the lower income stream (even if it means a negative return after accounting for inflation). The fear is that high-yield corporate bonds have a higher default rate. But according to Fidelity Investments, in order for high-yield bonds not to perform better than Treasury bonds over the intermediate term, default rates would have to rise from currently between 1 and 2% all the way to 10%.

According to a recent market analysis from Charles Schwab, Moody’s projects a peak high-yield default rate of 9.4% in the case of severe recession. Going back to November 2009, corporate bond defaults peaked at 14.5%. The Moody’s stress test uses an unemployment spike to over 13% and a dramatic rise in the cost of high-yield debt (to the levels seen in 2008–2009).

Schwab’s Rob Williams (Director of Income Planning) and Kathy Jones (Fixed Income Strategist) wrote: “We’re nowhere near either of these possibilities at the moment, in our view. Unless we see a severe economic downturn, yields north of 9% for high-yield bonds—where they are currently on a broad index—may be enough to compensate for volatility and defaults for more risk-tolerant investors. Bottom line: Adding yield when spreads compared to Treasuries widen, in our view, can make sense for investors interested in corporate bonds now that yields have risen.”

High-yield bonds collectively have average yields over 8%.

Certainly, if recession returned, conditions would change but at this point, concern of recession has eased. We find that using multi-sector bond mutual funds where the managers have flexibility to shift to the most relatively attractive segment of the global bond markets, is a good way to gain exposure to high-yield bonds.

~ Brooks, Hughes & Jones, Partners in Wealth Management, Tacoma, WA

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European debt crisis presents difficult challenges

Posted on October 6, 2011 | Leave a comment

The government debt situation in Europe has been the largest driver of market volatility over the past two months. Concern continues to grow that select European countries are close to defaulting on their loans. European banks may have catastrophic exposure to debt problems and there is concern that the problem could spread outside of Europe.

The best review of the situation that we’ve read is a Sept. 29 market bulletin from J. P. Morgan titled “Is a More Integrated Europe the Answer?” The bulletin analyzes the current economic situation among the 17 countries in the European Monetary Union. It provides a very good overview of the issues and suggests that solving this crisis will require “enormous financial, social and political costs.”

Some of the most notable points include:

  1. Most of the countries in the European Monetary Union (EMU) have different cultures, languages and economic strengths and weaknesses. There is common currency but no common fiscal oversight. There is no common Federal Reserve equivalent to provide liquidity to banks. There is also no ability to influence fiscal policy and taxes across borders.
  2. The unsustainable financial situation of a few outlying countries in the EMU is forcing politicians in the financially stronger countries to bail out both the euro and countries with burdensome debt. This decision might be good for the EMU as a whole, but is bad for individual countries. In comparing the U.S. financial crisis and taxpayer-supported bailouts of prominent companies, the article makes an interesting point: “imagine if the government wanted to allocate trillions of U.S. taxpayer dollars to help another country pay its bills!” This makes the European challenge very difficult politically.
  3. Given that the situation in the EU could lead to another global recession, the market strategists at J.P. Morgan encourage investors to “consider alternative strategies, such as long/short and market neutral approaches to help dampen volatility and provide greater diversification.”

This is what we have focused on over the past few weeks.

The complete market bulletin is available here.

~ Brooks, Hughes & Jones, Partners in Wealth Management, Tacoma, WA

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What we look for when picking a mutual fund

Posted on August 26, 2011 | Leave a comment

In theory, picking a good mutual fund should be easy. Just find a fund with an experienced portfolio manager who has consistently outperformed the fund’s relevant benchmark and buy some shares. Then repeat in each portion of the market so that you have a well-diversified investment mix.

In reality, while it’s possible to evaluate past performance and choose from funds that have peer-beating records, the more difficult job is to identify funds that have a high probability of continuing that performance. Performance is fleeting. Even funds that have performance among the best in their category may have built good returns on a small number of incredibly well-timed investments. Alternatively, some very good funds could have excellent long-term performance and good future positioning skewed by the impact of one or two investments that didn’t work in their favor.

Identifying funds with a repeatable process to add value beyond just buying the whole market is an ongoing and involved task.

A lot of things can change about a manager or a fund from year to year. We work to learn as much as we can about the manager or fund, so we are comfortable with its stability and understand how it will fit into our clients’ portfolios.

Important questions that we ask include:

  • How much of rising market returns does the manager earn and how much does the fund participate in declining markets? (Ideally, actively managed mutual funds capture most of – if not more than – a climbing market’s return and are able to avoid the full extent of downturns.)
  • How much flexibility does the manager have? (When we choose mutual funds, we generally prefer managers who are not constrained to invest only in a specific portion of the market regardless of whether it is in or out of favor at the time. We use exchange-traded index funds to get this inexpensive broad diversification instead.)
  • Have there been any changes to the manager or management team recently?  If so, how have those changes influenced the fund’s investment outlook or process?
  • How are decisions made to buy and sell a stock or bond?
  • Does the fund invest only in long-only positions in stocks or bonds or does it use derivative products to emphasize or de-emphasize certain exposures in the fund? (We’re not against fund managers who use of derivatives to some extent as long as the process and purpose are very transparent.)
  • Has the manager’s investment philosophy changed recently?
  • How much new money has been invested in the fund lately and has that affected either the number or the quality of holdings in the fund?
  • What have been the recent trends of the manager for underperforming or outperforming the fund’s relevant benchmark?  Why has this underperformance or outperformance occurred?
  • Have there been any changes to the basic characteristics of the fund?  Expense ratio, portfolio turnover, number of holdings, risk measures, etc.?
  • Does the fund have an institutional share class available so that we don’t have to pay the higher retail share class management fees? Or, can we aggregate client accounts to get into funds that otherwise would have an unapproachable minimum investment?
  • How will this fund fit in with the other funds in a client’s portfolio?  Are there other funds that could do a better job?
  • Is there a low-cost passively managed investment like an exchange traded fund that could be used in place of this fund which would provide similar investment returns?

How do we get this information?  Mostly through conference calls with the manager, reading annual and semi-annual reports for the fund, reviewing analyst’s reports and other third-party reviews.

This process doesn’t guarantee selection of the best future performance. In fact, we guarantee that in hindsight you will find better performers in every category over various time periods. But if the fund advances through our decision tree and we have high conviction in its expected returns compared to its known risks, then it makes the cut.

The worst thing we could do would be to constantly turn over our list of preferred funds in pursuit of the absolute best performance. It would create unnecessary reach for fractionally better results and drive up transaction costs.

That is not to say that we are not searching for new funds that offer attractive expected returns with better risk management. We certainly make changes. We just are not inclined to do it on a whim because a certain fund’s holdings were more in favor last quarter or last year.

~ Brooks, Hughes & Jones, Partners in Wealth Management, Tacoma, WA

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Slow economy is a drag on standard of living

Posted on August 25, 2011 | Leave a comment

Economists who aren’t predicting a double-dip recession are at least expecting a low-growth U.S. economy for an extended period of time. What is the impact of an economy that doesn’t grow at it’s historical annual rate of approximately 3% year over year?

Consider these thoughts from Bill Greiner, Chief Investment Officer for Scout Investments:

From the end of World War II, the economic growth rate (Gross Domestic Product – GDP) has been roughly 3.3% after factoring in population growth and inflation. Greiner writes that this level of economic expansion translates into a doubling of the after-inflation standard of living every 29 years.

If the U.S. can sustain only 2% GDP growth for an extended time in the shifting landscape of the emerging global economy, the standard of living in the U.S. would double every 64 years. This assumes that inflation remains close to historical precedent.

Slower economic growth could mean that an entire generation gets skipped in terms of improvements to standard of living. That’s a lot more meaningful than the seemingly small difference between an economy growing at 2% instead of 3%.

Of course, you could argue that our standard of living relative to the rest of the world is pretty good and we shouldn’t be too concerned with less advancement than we’ve experienced in the past 70 years. Perhaps the key takeaway here is the importance of investing globally where there are parts of the world, particularly in the emerging markets of Asia and Latin America, that are in the middle of doubling their own standard of living through significant economic gains.

You can read the Greiner’s full note here: https://www.umb.com/stellent/groups/public/documents/web_content/017282.pdf

~ Brooks, Hughes & Jones, Partners in Wealth Management, Tacoma, WA

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Stock performance often overcomes credit rating

Posted on August 25, 2011 | Leave a comment

The recent Standard & Poor’s downgrade of the United States credit rating probably drew more negative sentiment than it deserved considering that the reasons for the downgrade weren’t exactly a surprise.

Dr. Bob Froehlich, Chief Investment Strategist at The Hartford, provided some good perspective on the history of government credit ratings as they relate to subsequent stock market performance.

“While the loss of the coveted AAA credit rating is certainly a black eye for any country, it may not be the end of the world for a country’s stock market. History is filled with many examples of countries that lost their AAA ratings, only to see their stock markets go on to post strong performance a year later. Here are a few examples to think about. On March 30, 2009, Ireland lost its AAA rating, and 12 months later their stock market was up 20.8%. On April 12, 1995, Canada lost its AAA rating, and 12 months later their stock market was up 18.2%. On January 19, 2009, Spain lost its AAA rating, and 12 months later their stock market was up 40.7%. On May 6, 1998, Finland lost its AAA rating, and 12 months later their stock market was up 55.8%. Finally, on September 12, 1986, Australia lost its AAA rating, and 12 months later their stock market was up 86.4%. The point I’m trying to make is that other factors besides a country’s credit rating influence stock-market performance.”

It’s tough to envision returns this large out of the U.S. stock market over the next 12 months but it is not difficult to see gains from here. In fact, it’s not a stretch to conclude that the stock market may be less risky than the bond market at the moment if your goal is to outpace inflation.

~ Brooks, Hughes & Jones, Partners in Wealth Management, Tacoma, WA

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U.S. Stocks, Municipal Bonds Generate the Best Real Returns

Posted on August 12, 2010 | Leave a comment

Thornburg Investment Management recently released an annual report analyzing real returns. It is always interesting reading. Thornburg reviews returns for several types of investments and then subtracts expenses, taxes and inflation to determine which investments allow investors to keep the most return.

For example, if you invested $100 in the S&P 500 Index on December 31, 1979 and held it over 30 years to Dec. 31, 2009, the nominal return would have been 11.24% per year.  This increased your  $100 investment to $2,440. However, after subtracting taxes paid on dividends and capital gains and adjusting for inflation, the real return was 5.21% per year, turning $100 into $459.

So, how does this compare to other investment options? Over the 30-year period, the S&P 500 (representing large U.S. companies) provided the highest real return. The runner-up was U.S. small companies (4.81% average annual real return) and international stocks (4.55% real return). Municipal bonds, which are in most cases not taxed, outpaced other fixed income assets over this 30-year period.

Some other interesting points:

  • Over the 5, 10, 15 and 20-year periods ending Dec. 31, 2009, municipal bonds were the real return leader.
  • The 10-year real return of the large-cap S&P 500 Index was -4.21%, the worst of any asset category measured over 10 years.
  • Single-family homes are not a good investment. Over 30 years, their real return averaged 0.36%. Over the five years ending Dec. 31, 2009, they had a -4.19% real return.
  • Commodities have become a popular addition to globally balanced portfolios. There is expectation that commodities of all types including energy, agricultural and livestock will grow in demand as the world population grows. But historically, commodities have not added anything to wealth creation. The 30-year real return was -3.50 – 20 years (-1.84%), 15 years (-0.82%), 10 years (0.51%) and 5 years (-3.85%). The benefit of commodities comes in risk reduction. Since their returns do not typically move in the same direction as stocks and bonds, they can help reduce overall fluctuation in the balance of a diversified portfolio.
  • U.S. Treasury bills, often the preferred “risk-free” investment, are actually plenty risky. They exhibited negative real returns in each time period measured.

For a copy of the full report, including how these return patterns impact the sustainability of portfolios and income in retirement, please contact us at info@bhjadvisors.com or 253-534-8888.

~ Brooks, Hughes & Jones, Partners in Wealth Management — Gary Brooks, CFP®, Allyn Hughes, CFP®, CLU, ChFC, Nancy Jones, CFP®

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