With tapering still in the back of the mind of investors, the prognosis for tapering still remains unseen as dates of the tapering still are indefinitive and flaky at best. In the previous article, I advocated for keeping some bonds in your portfolio, whether it be individual, mutual fund, ETF, and now considering closed-ended funds. I still maintain that thesis but would like to throw out a bond investing strategy. At this time I preface my remarks by stating that the thoughts I'm about to pose are just my personal thoughts and may encounter resistance from seasoned investors.
I'm no fan of government-backed bonds- instead, I prefer corporate bonds- but the tragic reality is that the ball is in the Fed's court now. Earlier this year when investors saw "The Great Rotation" rotating out of bonds and into equities, I felt that the opportune time to invest in oversold bond funds would be able to give investors dividend income at a lower principal rate. I still think that this is a valid strategy, however with the tapering not having happened yet, I think that a better strategy lies in pulling most if not all money out of bond funds for now, wait until the tapering begins to happen and prompts interest rates to rise, and when the bond market has normalized, then jump back in. This assures an increase in dividend rates and ensuring that your principal value wasn't eaten up by capital depreciation incurred when the tapering began.
Two Common Strategies
I think that the tapering could be the catalyst to the end of the bond bear market because interest rates will eventually ride up and principal prices will drop, making a much easier entry point for investors. The two common strategies you see in the market would work here: market timing and dollar-cost averaging. These two are basic strategies that you may have heard incessantly over the years, but I still mention it because I still advocate for bonds.
This strategy would work more-so for people who have already gotten out of bonds but still do like bonds because of the stable dividend income. This can also work for people currently in bonds who want to add to their position but haven't. In a nutshell, wait until the tapering has begun or wait until a few months after the tapering has begun, and when interest rates begin to rise and prices fall, watch to see when prices and interest rates stabilize. When those two stabilize, then would be the time to jump in. By doing this, you can get in when prices are at a discount and have a higher coupon rate.
If you're not a believer in market timing, another strategy would be to keep your bonds and use the dollar-cost averaging strategy. Dollar-cost averaging would work in this case because assuming the scenario of a continued bond sell-off during tapering, buying more shares decreases your cost of capital while buying more shares entitles you to receiving more coupon income from the bonds, eventually balancing out any incurred losses and even giving you returns over a longer period.
"A Time & Place For Everything"
Taking into account the old cliché that there's always a time and place for everything, in investing, the same philosophy applies. The future of bonds is still seemingly up in the air, but we all know that tapering is coming- just have some dispute as to when. Holding bonds right now doesn't hurt because while we're waiting on tapering, you can still receive coupon income. I think that at least in the initial stages of the tapering, you should get out of bonds and wait on the sidelines until bond prices and interest rates normalize before getting back in.
I believe that once prices and interest rates normalize, more investors may be inclined to get back into bonds- with a variation on portfolio weighting. Retirees, middle-aged, and even young investors would find a steady income stream in bonds because by then volatility would have reduced. These statements are on the assumption that you not buy any government debt, just corporate debt.
Who I'm Watching
I've had my eye on closed-end funds as of late, but won't rule out ETFs that hold only bonds. Though the purpose of this commentary isn't to go into detail about the performance or to build a case of why one fund trumps others, I just want to give some names of funds that I've been looking at buying once the tapering has calmed down:
Western Asset Global High Income Fund Inc. (NYSE:EHI);
Managed High Yield Plus Fund Inc. (NYSE:HYF);
Templeton Emerging Markets Income (NYSE:TEI); and
SPDR Barclays Intermediate Term Corporate Bond ETF (NYSEARCA:ITR)
This commentary was really intended for two reasons: (1) continue my advocacy to keep bonds somewhere in your portfolio, and (2) to point out two strategies that would work for investors given an impending tapering from Washington DC. I continue to maintain my position that bonds belong in every investors' portfolio, however, I think that bonds would be better suited for your portfolio once the tapering has begun and prices and interest rates have stabilized.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. I hold bonds in my IRA in the American Funds American High-Income Trust (MUTF:AHITX).