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HomeBlogBattle for Yield in Perilous Fixed Income Arena

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Investing in Excellence

At Fragasso Financial Advisors, our focus is to provide a quality client experience for every client through each and every department. Our staff is hired, trained and focused on the personalized and professional interactions that you seek in helping you reach your financial goals.

Within our firm, we have an in-house Portfolio Management Department dedicated to the attention and ongoing management of your investments. Rigorous analysis and management of investment decisions are our business, which extends to the value we place on investing in talented professionals. Our expanded capacity within our portfolio management team continues to drive research, analytics and the collective wisdom among our specialists. Our newest additions, Michael Godwin, CFA, manager of portfolio strategy, and Matthew Karr, CFA, MBA, manager of investment research, are talented, experienced additions to the department’s analyst team, which includes Madison Nestor, CFA, investment analyst, and is led by Lisa Brignoni, CFA, AIF®, director of portfolio management. Contrast this structure with other advisors who may be making all of the investment decisions themselves, among the many other duties they perform for their clients. Other firms may also outsource their portfolio management, where decision making can be far removed from the client’s actual goals and needs. At Fragasso Financial Advisors, we keep our investment decisions and research through the centralized Portfolio Management Department in-house so that we can personalize decisions to your financial goals. Currently, one of the areas on which our portfolio management team is focused is the fixed-income market and the challenges we face in this low interest rate time. Below is a brief outline of how we have positioned portfolios within fixed income.

The Battle for Yield

The classic military maneuver known as feigned retreat is a tactic whereby an army pretends to withdraw in order to lure the enemy into a position of vulnerability. For the side that may be drawn into the feigned retreat, a sense of cautiousness, discipline and proper planning must be exercised in order to prevent capture by what appears to be an opportunity in battle.

During this period of very low interest rates, bond investing can seem analogous to feigned retreat. Investors are drawn into chasing higher yielding instruments without understanding the risk they may present. Many of these higher yielding fixed-income instruments carry low credit quality. In a nutshell, there is no free lunch. Bond investors may also be drawn blindly into following the Barclays U.S. Aggregate Bond Index,1 which by its fundamental make up holds a substantial portion of the most interest rate sensitive securities, U.S. Treasury bonds. As interest rates have continued to drop and at times remained stubbornly low, many wonder if that risk has not faded, and following the Barclays U.S. Aggregate Index is simply the most appropriate course of action. Could the potential for rising rates and following the index in this low yield environment be masked as feigned retreat for investors? While we cannot discern exactly when interest rates may begin to rise, we need to be prepared for its inevitability. This protection is at the core of our risk management process. At Fragasso Financial Advisors, we continue to invoke proper asset allocation and forward-thinking diversification among fixed income, despite its challenges in recent years when the U.S. Aggregate Bond Index rallied past many other fixed-income asset classes. What we have discovered is that since the financial crisis, traditional fixed income offers nearly half in yield and carries a 33percent higher duration risk.2 To illustrate the risk posed, consider for a moment the potential implications of this risk below.

As of Sept. 30, 2015, the ten-year treasury yielded 2.04 percent. A mere 1 percent rise in the ten-year treasury to 3.04 percent over a one-year period could have a relatively major impact on the treasury-heavy U.S. Barclays Aggregate Bond Index. Two general components make up most of the total return of the bond index, price change, and yield. If we experience the interest rate increase above we could potentially anticipate a negative price return of roughly 5.5%, partially offset by the 3% yield investors may receive, but ultimately netting roughly a 2.5 percent loss of one-year total return in the U.S. Barclays Aggregate Bond Index.3 Proper risk controls may come with a cost, but it pales in comparison to the potential of rising interest rates. This illustrates why chasing the U.S. Barclays Aggregate Index is viewed as a feigned retreat by many, including Fragasso Financial Advisors. It becomes especially precarious if interest rates begin to rise suddenly.dan5

At Fragasso Financial Advisors, we heed the advice of cautious fixed- income investing while seeking opportunities in yield advantage. This methodology is critical to reaching one’s financial goals. By combining holistic financial planning and attentive portfolio management armed with a plan prepared for the challenges of today’s market realities. Discipline in battle….or investing…is paramount to understanding that certain battles will be lost in the interim to win the overall war in the long term.

1The Barclays U.S. Aggregate Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. These major sectors are subdivided into more specific indices that are calculated and reported on a regular basis. It is not possible to invest directly in an unmanaged index. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk.
2 Source: Barclays, June 2015. Duration is a measure of interest rate sensitivity. The higher the duration, the more sensitive a fund/portfolio is to interest rate movements. Past performance is no guarantee of future results.
3 Illustration purposes based on every 1% interest rate change in the ten year treasury bond prices move by a percentage equal to the Barclays U.S. Aggregate Bond Index modified duration considering the current yield, roll, and yield change adjustment.