Long-term interest rates continued rising in March, with the yield on the 10-Year Treasury rate hitting 1.73% by the end of the month. However, the overall impact for SIS investors was minimal thanks to the natural “softening” effect of credit spread compression, which I explained in last month’s newsletter. In addition, some income portfolios benefited further from other market forces during the month.
As a reminder, credit spread compression has to do with the amount of extra interest an investor might require to go from a risk-free US treasury to a corporate bond of a particular grade. When interest rates rise due to investor confidence, credit spreads compress, creating a “natural softener” for actively-managed income portfolios. To explain further, if you were invested in a 10-Year Treasury bond, mathematically the value of your bond has dropped by about 7% since the start of the year. However, if you’re in one of our diversified portfolios of bonds and bond-like instruments, will you see your portfolio down by 7% in your April statement? No, because on average our bonds are down only by about 1-2% on the year, and even our preferreds (because they’re longer term) are only down 2-3%. So, depending on your allocation and strategy, your portfolio may be down just slightly, or not at all. In fact, on average, our actively-managed income portfolios are up in value year-to-date, thanks largely to the softening effect of credit spread compression.
In addition, certain types of investments such as REITs and BDCs have performed very well since the start of the year. Even though these vehicles carry more risk than individual bonds on a stand-alone basis, when peppered throughout an income portfolio, they can actually lower your risk when interest rates are rising. Depending on which ones you have, our REITs are up by around 10% on the year, BDCs by about 15%, and even some foreign bond Exchange Traded Funds (ETFs) are in the black.
So, again, while the current interest rate climate does create some challenges for income investors, it also shows how these challenges can be addressed with the right strategy, and even turned into opportunities in some cases. Of course, the main point is that although occasional drops in value in an income portfolio are almost inevitable due to market forces, with an income strategy, you know it’s only a temporary paper loss, and your income is unaffected.
Portfolio Transactions:
When managing your portfolio at SIS, we look for one of four possible “enhancement” trades while reviewing securities and possible transactions. Income generation is our primary goal for our clients, and we consider the following four portfolio enhancements before transacting: current yield, yield to worst (minimum projected annualized total return), interest rate risk, and default risk. The intents of these transactions are categorized as follows:
- Pay Me Now – Enhancing current yield
- Pay Me Later – Enhancing yield to worst
- Cover My Assets I. – Managing interest rate risk
- Cover My Assets II. – Managing default risk
We evaluate the transactions by determining whether they meet one, two, three, or all four enhancements. A baseball analogy for this: SINGLES, DOUBLES, TRIPLES, and HOME RUNS.
- Sold YUM 3.875% 11/01/23 @ $105.15 @1.67 %
- Purchasing TMUS 3.5% 4/15/31 @ $100.50 3.5%
- Yield Enhancement of 183 BPS
- Credit upgrade from BB+ to possibly investment-grade by 2023
*Ycharts.com
Note: The above trades were recent block trades and do not reflect all trades done on an individual specific basis. Sound Income Strategies, LLC is a registered investment advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Past performance is not an indication of future results. Be sure to first consult with a qualified financial advisor or tax professional about your specific financial situation before implementing any strategy discussed herein.
You are advised to give independent consideration to, and conduct independent investigation with regards to the information above in accordance with your individual investment objectives. Use of the Information is at the reader’s risk, is strictly intended for informational purposes in conjunction with the recipient’s due diligence, and should not be construed as a solicitation by Sound Income Strategies, LLC. Past performance will never indicate or guarantee future behavior. Sound Income Strategies, LLC does not represent or warrant that the contents of the document are suitable for you from compliance, regulatory, legal, or any other perspective. We shall have no responsibility or liability for your use or non-use of the document or any portion thereof.
Sound Income Strategies, LLC is registered as an investment advisor under the Investment Advisers Act of 1940 and is regulated by the SEC. Sound Income Strategies, LLC and its affiliates may only transact business or render personalized investment advice in those states and jurisdictions where we are registered or otherwise qualified to do so.
