The all-weather bond portfolio - CEO Finance

Chief Executive, The, Nov-Dec, 1992 by William N. Shiebler

Let's tally the results. Last year, the combined, weighted, after-tax yield of this portfolio of municipals, government, and high-yield bonds would have been 6.5 percent. With inflation running about 3.5 percent, that's not bad.

EXOTIC INVESTMENTS

A coda about mortgage-backed securities--products created in line with the trend toward securitization of less-liquid types of assets. Currently, these bonds are yielding a bit more than 7.5 percent and, therefore, are attracting significant attention.

But a strong caveat: Though investors can be richly rewarded in the MBS arena, they should be aware of the potential pitfalls. One problem with securities such as those issued by Government National Mortgage Association (Ginnie Mae) is prepayment risk. When interest rates fall, many homeowners refinance their mortgages. Similar to circumstances surrounding the recall of a bond, that means bondholders have their principal returned to them and must reinvest at a lower rate.

With all mortgage-backed bonds, the accounting involved can be difficult and individual investments perilous. If you're interested in using such securities to enhance yield, mutual funds are the way to go.

Ultimately, the mix of a bond portfolio should be determined by an individual's investment needs and the economic outlook. Regarding the latter, now is not the time to bet on interest rates making a strong move up or down. Our economists believe we are entering a period of fairly stable interest rates. Long rates are expected to decline to just under 7.75 percent, while short rates will probably begin to ratchet up a bit to about 4.2 percent by next spring, as the recovery builds momentum.

The all-weather portfolio, however, should fare well no matter which way the wind blows. If the recovery picks up steam, you may suffer a little principal erosion in your government and municipal bond portfolio as short-term rates rise, but your high-yield bonds will benefit.

On the other side of the coin, if the economy fails to accelerate, your high-yield bond position could be crimped, but the rest of your portfolio would hold strong.

William N. Shiebler is senior managing director of The Putnam Companies, a Boston-based investment-services firm with assets of $60 billion.