2018 brought fixed income investors four different rate hikes throughout the year, raising the Fed funds rate by 1% to a range of 2.25% to 2.5%. Fixed income investors started the first half of the year off in rough shape, as when interest rates go up, prices come down. Those holding ETFs and CEFs for bonds or other fixed income securities saw some steep losses. This was to be expected, with the Fed raising rates four times during the year. However, what wasn't expected was that even though rates were raised by the Fed at the end of the year, bonds rallied in the face of fear and the market worrying about a coming recession.
Here is what the year looked like for total returns for each of the major fixed income categories:
|Income type:||Treasuries 20+||Corporate Bonds||Build America||Municipal Bonds||Junk Bonds||Preferred Shares|
|2018 Return w/ Div||-2.07%||-3.76%||1.00%||2.60%||-4.00%||-3.90%|
Based on the above selections, the best-performing assets for fixed income ETFs were municipal bonds, both the taxable and non-taxable ETFs. In fact, the non-taxable SPDR Nuveen Barclays Municipal Bond ETF (TFI) gave out a total return of 2.6%, which is surprising, seeing that the yield is less than the taxable version. The worst performing were junk bonds giving a total return of about -4.00% based on the SPDR Bloomberg Barclays High Yield Bond ETF (JNK).
All in all, it wasn't the best year for fixed income ETFs, but their total returns were slightly better than the stock market averages, as most stock averages ended the year in the negative mid-single digits.
So, what does 2019 look like and what should we expect? Here are what the current prices and yields are as of January 08, 2019:
|Income type:||Treasuries 20+||Corporate Bonds||Build America||Municipal Bonds||Junk Bonds||Preferred Shares||CD's|
|Ticker:||TLT||LQD||BAB||TFI||JNK||PGX||1 Year CD|
|Discount to NAV||0%||0%||0%||0%||0%||0%||5 Year CD|
|% AAA bonds||99%||3%||13%||25%||0%||0%|
|% of AA bonds||0%||8%||51%||75%||0%||0%||2 Year Treasury|
|% of A bonds||0%||38%||16%||1%||0%||6%||2.50%|
|WAL duration||25 years||13 years||8 years||7 years||4 years||5 years|
|Monthly pay rate?||Yes||Yes||Yes||Yes||Yes||Yes|
The fixed income market has had a nice run up the past few months, and even YTD, the past week has had a nice run up. So prices have gone up and yields have come down. The market seems to be pricing in less, if any, rate increases for 2019 by the Fed. Personally, I wouldn't count on it, and I am still planning on 1 or 2 rate increases, which traditionally would mean that bond ETFs would go down so that their yields would increase. I am not expecting a massive slaughter like back a few years ago with the rate increase frenzy, but the fixed income market, in theory, should not have a stellar year this year if rates keep going up.
However, if the market is looking forward to 2020 or beyond and pricing in a recession, then the bond market could rally like it did at the end of 2018, even with rates being increased by the Fed. Either way, expect volatility this year. If you don't like watching your money go up and down, it would be better to have a buy-and-hold to maturity strategy of individual bonds or CDs. For those pursuing the buy-and-hold to maturity strategy, with rates nudging up the past year, reinvesting money will give you a slightly better yield with some more interest income to spend this year.
For those investing money in ETFs or Closed-End Funds, expect more ups and downs. I would guess total returns for 2019 will be subdued at best. Probably, similar to 2018, with total returns ranging from -5.00% to 3.00%. Don't expect a stellar year with total returns of 10+%, unless a recession comes and the bond market rallies.
For those with new money to invest, it seems logical that investing it in 1-2 year CDs or Treasuries would be the best. Why is that? Long-term rates are actually about the same as short-term rates. In fact, in some cases, long-term rates are lower than short-term rates, so it wouldn't make sense to tie your money up in long-term securities like a 30-year treasury, yielding 2.92% when you can get a 1-year treasury yielding 2.56%. The only reason you may not want to do this is if you believe rates will drop drastically over the next year or two and you will need to reinvest your money at lower rates. I don't think this will happen though.
For those wishing to invest in ETFs or Closed-End Funds and who don't mind market volatility, I would recommend municipal bonds. For those in a high-income tax bracket, a mixture of both higher yielding taxable and non-taxable munis would be a good place to start. For those in the lower or zero income tax brackets, the taxable munis would be a great place to start investing money.
For the taxable municipal bonds, I would recommend BlackRock Build America Bond Trust (BBN), Guggenheim Build America Bonds Managed Duration Trust (GBAB), and Invesco Build America Bond Portfolio ETF (BAB). BAB is good for those who don't like leverage and currently yields 3.8%. BBN and GBAB have higher yields (around 7%) and are what I have been holding in my portfolio, but they are leveraged, which will make the volatility more severe, both to the up and down side. They both have higher quality A, AA, and AAA bonds though, so credit quality isn't much of a risk. I have enjoyed having these two Build America Bonds funds in my portfolio since 2014 and they have not disappointed me. The current income is great, plus when the stock market has gone south, these bonds have done well at bringing balance to the portfolio. Since inception in 2010, GBAB has returned 8.53% in total market returns and BBN has returned 9.75%. If you have money to invest in just one of the two, BBN seems to be the clear winner both in terms of its current status and total market return since inception.
Below is what GBAB and BBN are currently looking like as an investment:
|Income type:||Build America||Build America|
|Discount to NAV||-0.63%||-4.76%|
|% AAA bonds||1%||3%|
|% of AA bonds||60%||41%|
|% of A bonds||26%||45%|
|WAL duration||5.38 years||32 years|
|Monthly pay rate?||Yes||Yes|
For those wishing to invest in the non-taxable municipal bond market, one should first consider the state you live in. If you pay state taxes, investing in municipal bonds from your home state will save you money on state taxes as well. If you are looking to diversity in many different states, then there are many different ETFs and CEFs out there that all have a decent yield on them. Two of my favorites are VanEck Vectors High-Yield Municipal Index ETF (HYD) and Invesco Value Municipal Income Trust (IIM). They yield 4.44% and 5.24% respectively.
Overall, the best bet for your money, if you are looking for a safe investment, would be to stick with short-dated investments for 2019. Many of them are even yielding more than their long-term counterparts. 1-year CDs and Treasuries now have decent yields on them, especially considering they are almost yielding as much as their 5-, 10-, 20-, and 30-year counterparts.
For those who can handle volatility, the Taxable Municipal Bond Trust by Black Rock (BBN) looks to be your best bet for a good, durable income source of 7.57%, not including capital gains or losses. With a 9.75% total return since inception, it has done remarkably well. If you would like to get a better overview of it, you can read a more in-depth article I wrote here.
Good luck in 2019 and as always, do your due diligence!
This article was written by
Disclosure: I am/we are long BBN, GBAB, IIM. 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.