If you want to know why many adventurous income funds performed
so well the past year despite so much angst about the direction of
interest rates, take a gander at page 24 of the Third Avenue
Focused Credit Fund's latest shareholder report: "Debt instruments
that had been traditionally sold as 'safe' have simply paid too
little to contend with rising interest rates or even modest
inflation. Those instruments that have traditionally been
considered as 'risky' are actually better positioned to perform
well under current economic conditions." Third Avenue Focused
Credit, which buys low-rated corporate bonds, returned 15% in the
first 11 months of 2013.
Rick Rieder, the bond chief of the BlackRock funds, says much
the same, only more succinctly: "Safe assets are risky and risky
assets are safe." And consider the headline in a recent report from
Bank of America Merrill Lynch: "Fear not the Fed."
Say what? Isn't the Fed about to bring us Bondmageddon by easing
the pedal on its super-accommodative monetary policy? And won't the
resulting rise in long-term interest rates wreck just about all
income-producing investments? But the conventional wisdom is often
wrong, and that may turn out to be true in 2014, at least for
certain supposedly risky income investments.
Moreover, although the Fed is likely to cut back its
$85-billion-a-month bond-buying program soon, that doesn't mean the
central bank is about to clamp down on the economy. Most important,
the Fed is likely to keep short-term interest rates near zero until
2015. If you're set for life or will need your money soon, go ahead
and bank your cash. Otherwise, get in there and invest. (Editor's
Note: After this column was first published in the February 2014
issue of Kiplinger's Personal Finance magazine, the Fed announced
its plans to begin tapering its bond-buying program in January
2014. For more information, see
Interest Rates and the Fed's Taper
Here are five income categories that should continue to perform
1. High-yield corporate bonds had a winning year in 2013, so the
category is attracting a lot of money, which isn't necessarily a
plus. And credit standards for some new junk bond issues have been
lax. But the 4-percentage-point gap between the yield of the
average junk bond and the yield on ten-year Treasuries is wide
enough to support prices. If junk bond prices temporarily fall 5%,
bargain hunters will appear. You'd be wise to join them.
2. One rap on real estate investment trusts is that they often
borrow to expand or to refinance their debts, leaving them
vulnerable to rising rates. Property-owning REITs had a rare
nonrecession off year in 2013, essentially breaking even through
November 29. But independent analyst Brad Thomas has found that in
16 prior periods of rising Treasury yields, property REITs produced
positive returns 12 times. The sluggish 2013 was mainly the result
of profit-taking after a long period of super performance. Expect
better results in 2014.
3. Preferred stocks took it on the chin last spring and summer.
But they have steadied as buyers find yields that can be double or
triple those of the same issuers' common stocks. Some preferreds
now yield 6.5% to 7%.
4. For a while, even municipal bonds fell victim to fear of the
demonic Fed. But tax-exempts are less sensitive to rate gyrations
than, say, Treasuries and mortgages. The troubles of the one and
only Detroit illogically resulted in selloffs of bonds from
thousands of sound localities. As a result, you can easily get
tax-free yields of 3% for ten years and 4.5% for 30 years from
highly rated municipalities.
5. Finally, what about the stock market, which contains many
issues paying 3%, 4% and up? Yes, the market may experience a
hiccup when the Fed makes clear that it's finally ready to taper
its bond-buying program. But that will happen only when the Fed
believes the economy is strong enough to withstand higher bond
yields--a plus for stocks.
sees a winning year for the market in 2014