Recent Market Developments
These days it is getting increasingly difficult to make sense of the economic environment. Good news is often seen as bad news, and bad news will sometimes move the markets higher. Sometimes the markets get both good and bad news on the same day.
As an example, on June 5, 2006, the equity markets declined significantly after comments by the Federal Reserve Chairman which gave conflicting signals about the economy. The bond markets, especially treasuries, were not immune. On the one hand, Chairman Bernanke stated that economic growth appears to be moderating (which would generally be seen as a positive for bonds) however, core inflation remains at the higher end of what is deemed acceptable (a negative for fixed income investments).
These conflicting signals can be unsettling, both for institutional and retail investors. While it may be tempting to forgo the bond markets, particularly when the yield curve is flat and short-term rates are competitive with long-term yields, trying to time the market has proven unwise for bond investors (see chart below)
Thornburg’s Philosophy
Against these conflicting signals, Thornburg maintains its consistent process and philosophy for managing fixed income investments. We believe that laddering, combined with solid credit quality, represents a sound core strategy for long-term investors.
Laddering
At Thornburg, we operate under the belief that a straightforward process – laddering – lays the foundation for strong risk-adjusted performance. Rather than trying to predict the direction of interest rates, laddering involves building a portfolio of bonds with staggered maturities so that a portion of the portfolio will mature each year. Thornburg has applied this philosophy for over two decades, in periods of rising and falling interest rates, and this approach has been proven to mitigate risk and volatility.
Avoidance of Undue Credit Risk
For the past several years, credit spreads (the difference between yields on lower quality and higher quality issues) have been quite low. Bond investors have been rewarded for taking more risk, as the economy has remained strong and bond default rates have been kept in check.
In his recent speech however, Chairman Bernanke indicated that economic growth appears to be moderating. Were that slowdown in growth to accelerate, the risk of default could increase.
Thornburg has historically avoided making bets about the strength of the economy. Rather, our bond portfolios are run with the idea that high credit quality combined with widely diversified portfolios makes the most sense for risk-averse investors.
A Focus on Risk-Adjusted Performance
The current market is unsettling, with conflicting signals about the economy being released every week. This has led to volatility in both the equity and fixed income markets. Rather than trying to determine whether good news is truly good and if bad news is really as bad as it appears, Thornburg instead relies on time-tested principles in managing its bond portfolios. First, that laddering makes sense in multiple interest rate environments. Second, that investing in higher rated issues is more prudent for risk-adverse investors. These principles have protected investors in multiple market environments and has led to strong performance, both absolute and risk-adjusted, over time.
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Shares in the Fund carry risks including possible loss of principal. As with direct bond ownership, Funds that invest in bonds are subject to certain risks including interest-rate risk, credit risk, and inflation risk. The principal value of bond funds will fluctuate relative to changes in interest rates, decreasing when interest rates rise. Unlike bonds, bond funds have ongoing fees and expenses. Shares in the fund are not deposits or obligations of, or guaranteed or endorsed by, any bank, the Federal Deposit Insurance Corporation, the Federal Reserve Board or any government agency.
The laddering strategy does not assure or guarantee better performance and cannot eliminate the risk of investment losses.
Carefully consider the Fund’s investment objectives, risks, sales charges, and expenses; these are found in the prospectus, which is available from your financial advisor or from our download library. Read it carefully before you invest or send money.
The views expressed by the author reflects his professional opinions and should not be considered buy or sell recommendations. These views are subject to change.
U.S. Treasury bonds are used to finance borrowing by the U.S. government. In return purchasing the bond, the government pays the owner of the bond interest, called the coupon rate. The note can be sold prior to its maturity in the secondary market. Since the prevailing interest rate when a bond is re-sold will usually be different than the coupon rate, the price of the bond must adjust so that the financial return (called "yield-to-maturity") is consistent with prevailing interest rates.
