Profit from debt

Black Enterprise, April, 1995 by Gracian Mack, Frank McCoy

DESPITE THE WOEFUL PERFORMANCE of '94's fixed-income market, bonds and other fixed-income securities should still be a part of any savvy investor's portfolio. But as last year's performance makes clear, a disciplined and pragmatic strategy is essential. Such a strategy should set up a steady income stream to increase wealth and enhance savings for future investments.

Last year was a real test of this approach. Long-term U.S. government bond returns fell to their lowest point in history, and analysts had to look back 30 more years to find worse returns for intermediate U.S. government bonds. Bonds of all categories--global, high quality, junk and municipals--recorded losses of between 2% and 4%.

Maintaining a diversified portfolio can, however, minimize losses. Certainly, there will always be periods of downturn since business runs in cycles, but you can be sure that things will lift again. The challenge is to set yourself up to take a first-strike advantage of opportunities when they arise.

This is true whether you're building a balanced portfolio or making a market play to create income that can be counted on over the long haul. Either way, it's important to understand the role bonds play in the fixed-income market.

To better explain the nuances of fixed-income investing, BE hosted its First Annual Black Enterprise Fixed-income Roundtable at our New York headquarters. A cross section of experienced specialists participated.

The group comprised Ladell Graham, co-founder, president and chief investment officer of Houston-based Smith, Graham & Co., the largest African-American-owned fixed-income asset manager with $1.5 billion invested; Marcos Jones, chief economist and director of fixed-income research for Raymond James Associates, the St. Petersburg, Fla., financial planning giant and fiull-service brokerage firm; Charles H. Self III, vice president of the Chicago money management firm, CSI Asset Management; Cynthia Plouche, managing director and chief investment officer with Abacus Financial Group, another Chicago firm; Vernon Reid, a money manager with 15 years of fixed-income experience, and principal and chief investment officer of Baltimore-based V.A. Reid & Associates; and William Michael Cunningham, a Washington, D.C.-based investment advisor, president of Creative Investment Research & Management and developer of a mortgage-backed security created by loans from minority financial institutions.

Their crystal ball gazing, which follows, gives specific advice for experienced long-term investors as well as newcomers, who have heard about the general predictability of fixed-income investments.

BE: Where should our readers put their fixed-income investment?

CYNTHIA PLOUCHE: Before we consider where, I think it's important to consider why. Individuals need to decide what their strategy should be, and what they want that strategy to do for them. Currently, there's a lot of cutting of social programs. Individuals having to offset those costs ask, "How am I going to put my nest egg away? How do I plan for my children going to college-or for other foreseeable debts?" You have to understand why you're investing.

VERNON REID: That's true. And I think that we're all in agreement that, as a people, African-Americans have been overly conservative with almost everything we do. I would argue that we have to diversify our investments and increase our rate of return. Too many of us keep practically all of our fixed-income investments in low-yielding bank accounts or savings bonds.

LADELL GRAHAM: Yes, if we look at individuals who keep their money primarily in bank accounts, CDs or other types of very conservative investments, the yield of nearly 8% that you can get today on five-year government securities looks pretty good. You could capture almost 90% of the return including 30-year bonds, now yielding about 8%, while locking yourself into only four- or five-year maturities. That means you'd have significantly less risk should interest rates shoot up well above 8% beyond that five-year period. You wouldn't have to wait 30 years for the bonds to mature, even if it happened before then.

MARCOS JONES: You're absolutely right, considering today's fairly flat yield curve. You're not going to get a significantly higher interest rate on a 30-year bond than you would on a five-year bond.

REID: Ladell made a good point about savings accounts, which are yielding about 4% to 5%, and CDs. Even if you ignore five-year securities, you'd be better off investing in a money market mutual fund that yields 5%. You'd pick up an additional 1% without any additional risk. Similarly, instead of buying a five-year savings bond at 6%, investors should consider buying a five-year Treasury note directly from the Federal Reserve, which currently is yielding 7 5/8%. These notes come out every month.

BE: You can buy Treasuries directly from the Federal Reserve without paying any brokerage fee, but how should an investor structure his or her portfolio?

CHARLES SELF: There are three major ways you can structure the maturity spectrum of a fixed-income portfolio. The first is the "ladder" method, where you hold different instruments with maturities staggered over different periods of time. Second, there's the "bullet" structure, where your portfolio is mostly in intermediate securities, with less cash and longer securities. Or you can take the "barbell" approach, in which you evenly mix cash and shorter maturities with much longer ones. Adopting one strategy or another depends largely on where you are in the economic cycle, where the yield curve is, and where you think the yield curve will go. I think that most individuals should have a laddered strategy; otherwise they are playing the unpredictable interest rate market.