By Jonnelle Marte
Federal Reserve Chairman Ben Bernanke told lawmakers the economy was recovering at a “frustratingly slow” pace on last week, reinforcing last week’s announcement that rates may stay near zero for longer than expected. But advisers say there are still ways for income-hungry investors to find decent yields.
Bernanke warned lawmakers that investors could lose confidence in the government and the economy if the U.S. fails to manage its fiscal policy. He also pointed out that consumers remain wary and skeptical of whether the job and housing markets are really improving. The chairman’s bearish tone — along with the news that short term interest rates could stay low through 2014 – has prompted some advisers to look for strategies that could help them boost yield. “We’re really seeing a scramble of people looking for alternatives,” says Thomas Saake, co-portfolio manager of the $25 million RCM Short Duration High Income fund (ASHAX).
Savers will have to put up with sinking bond yields and less attractive rates on savings accounts, experts say. It also comes at a time when more Americans are banking, and not investing their money, which puts them at risk of watching their earnings whittled away by inflation. Advisers say there is some hope for investors. “There are definitely ways to get income,” says Anthony Valeri, fixed income strategist for LPL Financial “It’s a matter of how much risk you’re willing to take.”
Here is a look at some strategies for boosting yield:
Conservative investors looking for the safety of government bonds but who want to earn more than Treasurys should consider mortgage-backed securities, says Valeri. “Mortgage-backed securities are a good way to get some yield while taking on almost no credit risk,” says Valeri, who recommends investors put 20% to 30% of their bond portfolios in mortgage-backed bonds depending on their risk tolerance. With average yields of 2.5% on the Barclays Capital U.S. Mortgage-Backed Securities index, mortgage bonds have a yield advantage of 1.25 percentage points over comparable Treasurys.
Experts say the bonds could also see price gains if the Federal Reserve rolls out another round of bond buying in the mortgage bond market. And they would rally along with Treasury bonds if concerns about the economy push investors into safer bonds, says Jim Holtzman, an adviser with Pittsburgh-based Legend Financial Advisors who is increasing most clients’ allocation to the sector to roughly 6% from zero last year. Valeri uses the $543 million Federated Income Trust (FICMX) because it invests heavily in Fannie Mae and Freddie Mac backed mortgage bonds, which are offering better yields than Ginnie Mae bonds. On the downside, yields on the bonds have come down in recent weeks, making other sectors more appealing. Mortgage bonds could also tumble in value if the economy improves and investors begin to demand higher yields for owning government bonds, adds Holtzman.
Many investors have flocked to emerging-market bonds following the news that yields could stay near zero for another two years. Flows into emerging-market-bond funds hit a 24-week high in the week ending Jan. 25, according to EPFR Global. The bonds offer a middle ground for investors who are willing to take on more risk than in government bonds but aren’t yet comfortable with corporate bonds, which could be sold off if the economy takes a bad turn, says Valeri. Advisers recommend focusing on Asia and Latin America, which are expected to have stronger economic growth than areas of Europe and the Middle East. Emerging-market bonds may also get a price boost if governments cut interest rates in the coming months, a scenario that is becoming more likely after several countries raised interest rates last year, says Valeri. But investors should be aware that recent gains in the U.S. dollar have hurt emerging-market bonds denominated in local currencies, adds Holtzman.
Some advisers also recommend a more aggressive approach for investors prioritizing yield: corporate bonds. “It’s the easiest way to get yield in your portfolio,” says Valeri, pointing out that yields on high-yield bonds shot up last year due to worries over Europe. Those fears have calmed a bit since then, he says, but they still remain a risk. That’s why investors should stick to short-term high yield bonds, which should see a milder blow to bond prices if investors once again become concerned about the way Europe could drag down the U.S., says Saake. Corporations also have more cash on hand than they did a few years ago when the recession hit, meaning they are better prepared to handle a potential slowdown, says Saake. High yield corporate bonds currently have an average yield of about 7.5%, but yields are lower on shorter term bonds, he adds.