Alternatives and Strategies to Handle the Bond Bubble

by: Gregory Skidmore

In response to concerns that the fixed income markets are becoming increasingly risky, CalPERS, the largest public pension fund in the US, is reducing some of the risks in its fixed income portfolio. In addition, reports that institutions have shifted their allocations to stocks have begun to surface.

This is in stark contrast to the current investment patterns of individual investors who are pouring assets into bond funds and willing to buy low quality debt in search of yield. Corporations are taking advantage of this by issuing low quality debt to investors who are desperately searching for higher yields. Individuals appear to be doing what they always do, which is buy into the latest investment bubble.

What should individual investors do?

In my view bonds should always be a part of an investor's portfolio. However, now more than ever investors need to be very careful taking on additional credit or duration risk to get extra return. Right now bonds do not yield much and there is nothing to be done about this, except be patient.

I am recommending that clients to keep duration short and quality high. These are the areas least likely to be impacted by a change in interest rates or a deterioration in credit quality should the global economy double dip.

Some Short Term Bond ETFs that are worth consideration include:
(NYSEARCA:SHY) - iShares Barclays 1-3 Year Treasury Bond Fund
(NYSEARCA:BWZ) - SPDR Barclays Capital Short Term International Treasury Bond ETF
(NYSEARCA:ELD) - WisdomTree Emerging Markets Local Debt Fund
(NYSEARCA:BSV) - Vanguard Short Term Bond Index
(NYSEARCA:CSJ-OLD) - iShares Barclays 1-3 Year Credit Bond Fund

If you find yourself frustrated with bond yields, that's normal. We're all frustrated with bond yield, just remember being an investor takes discipline, and sometime that requires accepting low positive returns to avoid a huge loss.

Disclosure: Belray Asset Management holds positions in: SHY, BWZ, and BSV