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Yesterday I was asked for my reaction, in terms of portfolio construction, to the outlook change for the US debt (this may have been an interview or just a more casual email conversation, I'm not sure). Along the way the interviewer pointed out that it is hard to avoid treasuries.

We all know what he meant of course but just because treasuries are easy to access and there are plenty of them available does not mean we have to own them (either individual issues or funds). The only US treasuries we own are legacy positions that clients may have brought with them so the yields are worth holding on to.

Long time readers will know my belief in avoiding spaces where the risks (relative to the history of the space) are elevated or the fundamentals have obvious problems. With treasuries this has meant interest rate risk for quite a while now (prices can stay high for a very long time) and with muni bonds, which we also avoid, I believe there is credit risk. Even if Meredith Whitney turns out to be wrong in terms of magnitude I prefer to not have to even think about it.

There are many tools with which to build a fixed income portfolio and still avoid obvious trouble spots or at least minimize the exposure.

For now "safe" yields are very low. We allocate quite a bit of our (relatively) safe fixed income allocation into short dated high quality corporate notes. With a 2013 maturity date if rates go up a lot a meaningful price decline is unlikely because of how soon the notes have to pay out at par. The yields in the space are low but quite a bit higher than treasuries with like maturities; 70-90 basis points is better than 20. There are obviously plenty of ETFs in this space but the downside is that there is no par value to return to. The best middle ground is probably the Guggenheim BulletShares (BSCD), which terminate when the last issue in the fund matures.

We do a lot with foreign sovereign debt issues. We own debt from several countries including Norway and Australia. Individual issues can be difficult to access for individual investors but the fund space is improving here. The first funds are all heavy in Japan but we are starting to see a next generation of these funds coming that avoid Japan. The first one came out recently from WisdomTree and it is Asia ex-Japan (DND). There is also the Aberdeen Asia Pacific CEF (FAX) which has always been heavy in Australian debt (some clients own FAX), there is a Canadian preferred stock ETF that someone has in registration that could also turn out to be useful in this regard.

We do own TIP from iShares so there is some US treasury exposure but I feel far more confident here than with plain vanillas. The monthly payout has been all over the place (not unusual for an ETF) ranging from zero to pretty decent but it has generally done well.

Another space is emerging markets with the PowerShares Emerging Market Bond ETF (PCY). The paper is denominated in USD but there are times where the fund exhibits dollar sensitivity. We also own the Vanguard GNMA Fund (VFIIX). This fund has had a dividend cut a couple of years ago from four cents a month to three, which is obviously noticeable, but the historically low volatility of the fund makes it a good hold. We own one bank preferred stock which has a pretty good yield and I am quite certain the bank will not fail and we own one other closed end fund which is very un-volatile as CEFs go.

There a lot of funds that although they do not own bonds could be thought of as bond proxies or bond substitutes. A while back I wrote about the Collar Fund (COLLX), which owns mostly volatile stocks that it collars with options. Part of the marketing is that the fund can be a bond substitute. Based on price action this might be true but not based on payout. If the idea of bond proxies interests you then you may find some suitable candidates within the various absolute return niches.

Source: 'It's Hard to Avoid Treasuries' You Say? Not True