August 2, 2015

Believe it or not, both short and long term interest rates are at a 5,000 year low. And no, that is not a typo. No wonder there is a global search for income! On this week’s WEALTHTRACK we are discussing how to find reliable income producing investments for retirement. Thornburg Investment’s Five star rated municipal bond manager, Chris Ryon and fixed income guru Martin Fridson reveal their secure income strategies.

CONSUELO MACK: This week on WEALTHTRACK, as sources of income either dry up or become too expensive our intrepid guests , five- star rated municipal bond fund manager Chris Ryon of Thornburg Investment Management and fixed income guru, Martin Fridson of LLF Advisors find streams of income in out of the way places, next on Consuelo Mack WEALTHTRACK.

Hello and welcome to this edition of WEALTHTRACK, I’m Consuelo Mack. As a journalist I am the fortunate recipient of research from some of the financial industry’s top firms. One of the headlines that caught my attention recently came from Bank of America Merrill Lynch. It read: “The Lowest Interest Rates in 5000 Years.”

I knew that rates were at record lows but I had no idea that it went back five millenia. Here’s the chart. Yup, it starts at 3000 BC. It shows both short term and long term interest rates and it takes us, in a very compressed fashion, to the present 5000 year low. That’s what I call putting today in historical context!

It is no wonder that there is a global search for income. Of course not all interest rates are trading at record lows. Indeed some have been going up, especially where there is trouble.

Take triple tax exempt municipal bonds issued by Puerto Rico, whose credit rating was reduced to junk status last year. The U.S. territory is the third largest municipal bond issuer in the country, after California and New York despite the fact that its population is the size of Oklahoma’s and its GDP is smaller than that of Kansas. Unfortunately and not surprisingly, it is broke, which is why its rates have soared.

But issuers such as Puerto Rico and Greece are the exception not the rule. Government and corporate bonds have been in a three decade bull market, driven higher as interest rates fell, which led stock investor Warren Buffett to opine as early as 2012 that “Bonds should come with a warning label.”

Should they? Where else can you go for income? This week’s guests are two income pros.

Martin Fridson is the Chief Investment Officer of Lehmann Livian Fridson Advisors, a wealth management firm specializing in income investing that he co-founded in 2013. Fridson is a recognized expert in fixed income. Once dubbed the “Dean of the high yield bond market” he was the youngest person ever inducted into the fixed income analysts society hall of fame. Christopher Ryon is a Municipal Bond Portfolio Manager at Thornburg Investment Management. Among the multiple funds that he manages is the Limited Term Municipal Fund, rated five-star by Morningstar. Before joining Thornburg in 2008 Ryon was the head of the Long Municipal Bond Group at Vanguard Funds where he oversaw the management of more than $45 billion dollars in 12 intermediate and long-term muni funds. Thornburg is a sponsor of WEALTHTRACK but Ryon is here because of his independently recognized track record.

I began the interview by asking both guest if bonds should indeed now carry a warning label?

CHRIS RYON: Bonds have an important place in a well-diversified portfolio. Yes, we’re at the tail end or what appears to be the tail end of a 30-year bull run in bonds, but investors should realize there’s a reason to keep them in their portfolios. You want to have stocks, bonds, real estate, cash even though it doesn’t yield a lot, and the reason being is it provides ballast in case we’re wrong and rates stay at a low level for a prolonged period of time, and they also move counter cyclically to your stock portfolio. So in a well-diversified portfolio they have an important place even if in today’s environment they are overvalued.

CONSUELO MACK: Warning label. Should they have them, Marty?

MARTIN FRIDSON: Well, I think that may be a little extreme in that they’re going to be all right from a credit quality standpoint if you’re keeping an eye on that, and what you really need to be concerned about is a permanent loss of capital. You shouldn’t wake up in the middle of the night in a cold sweat about some volatility which we’re likely to have, but really the key thing is to avoid the permanent capital losses that would come from owning bonds of insufficient quality such as they default and you lose both your interest and your principal.

CONSUELO MACK: You mentioned volatility. One of the big issues being raised among bond observers is the lack of liquidity in the bond market, so Chris, how big a concern for you is the illiquidity in the bond market?

CHRIS RYON: It’s significant. We’ve had regulations and regulators have been trying to … they’ve pushed investors out the risk spectrum because of the Fed’s very accommodative stance on short part of the market. Jeremy Stein noted that in February of 2013. At that time he goes, “If losses are incurred by people who have moved out the risk spectrum, that’s fine as long as it’s not systematic.” Now they’re beginning to worry about that, and my big concern is that they put on more regulation to fix a problem of this over-accommodative Federal Reserve policy. Zero interest rates were important when we were losing 500,000 jobs a month like we were between May of ’08 and May of ’09, but right now we’re adding 250,000 jobs a month. Now the liquidity has shrunk especially in the municipal bond market. Dealer …

CONSUELO MACK: Why especially in the municipal bond market?

CHRIS RYON: Well, it has shrunk in all segments of the market, but as a municipal bond manager I’m overly sensitive to what’s happening in my market. Dealer inventories in municipal bonds have shrunk from about seven and a half percent of volume in mutual funds and ETFs down to two and a half percent. So that’s a two-thirds shrinkage. In the corporate market we’ve also seen as investors have moved into bonds out of stocks and out the risk spectrum that right now ownership of corporate bonds and ETFs and mutual funds has risen to about 20 percent which is in line with the municipal bond market, but that used to be less than 10 percent because corporate bonds were owned more by institutions than indirect retail ownership. Now what happens is in the municipal bond market when retail ownership gets spooked by rising rates, they sell their mutual funds. What happens if we have a double barrel event and you see selling in municipal bond mutual funds and corporate mutual funds at the same time? A dealer’s going to have to make a choice. Where do I allocate capital? That could exacerbate the problems and cause bigger price disruptions.

CONSUELO MACK: How worried are you about liquidity in the fixed income markets, Marty?

MARTIN FRIDSON: Well, I agree with everything that was said, but I want to put this in perspective a little bit. It’s always ugly when you get into a bear market. You have price gaps and drops that are not just the quarter of a point but very sharp drops in a single day. That’s happened in all the previous cycles, and it will happen again in the next cycle. When you talk about the dealer inventories, it’s very important to keep in mind that it’s not as if the dealers were ever there stabilizing the market. I mean that’s what specialists on the New York Stock Exchange were required to do with their capital. There’s never been an obligation for the so- called market makers in the corporate bond market to use their own capital and lose money. One of the things that you can count on is when the bear market begins you’ll hear the phrase, “Don’t try to catch a falling knife.” This phrase comes back in every cycle as if it’s never been heard before, and dealers are just going to step aside as they have in previous cycles until the prices start to look attractive. There is some effect of the clampdown on proprietary trading, but I think there are some hedge funds and other players who will step into that role of being the bottom fishers when that time comes. So I think it’s going to be hard even after the fact to say how much worse this cycle was because of the regulatory changes which I agree are problems, so for me to sit here and say, “Here’s how it’s going to be,” is even more crazy because you’re not in the same circumstances that you were, and it’s going to be very hard to compare. So it’s going to be a difficult period as rates ratchet up, no question.

CONSUELO MACK: What is the strategy then for individual investors? As Marty was just saying before that one of your goals is to avoid the permanent loss of capital. You want to preserve principal. What kind of a strategy? How do we protect ourselves from that? How are you doing it at Thornburg?

CHRIS RYON: There are two ways. First of all, investors have to have a proper investment horizon. We suggest two to three years. I also …

CONSUELO MACK: That’s as opposed to six months.

CHRIS RYON: As opposed to 60 days. I’ve had phone calls from advisors saying, “My client moved from a money fund to your bond fund. This was when the taper tantrum hit and has lost money.” I go, “What’s their investment horizon?” “Well, they had a three-month investment horizon,” and I told him that I know you want me to tell you everything’s going to be okay, but with that short of an investment horizon, I can’t say it. If you told me it was a year or two years, the probabilities rise that everything would be okay.

CONSUELO MACK: If you’re investing in bond funds or bonds for instance, then you should stick with them because if you guys have done your homework, the credit quality should be fine. You’ll get your money back. You won’t have the permanent loss of capital.

CHRIS RYON: Yes. If you go back to 1994 when the Fed started raising rates, short term rates go up 200 basis points. Long-term rates go up 100 basis points. Intermediate and long- term bond funds as measured by some indexes woefully underperformed short-term bond funds over that 12-month period, but if you had stuck it out and held it for two years, ’94 and ’95, the annualized return of intermediate and long bond funds outperformed the short bond funds because rates started coming down at the end of ’95 when the market realized the Fed was serious about fighting inflation. Short-term rates stayed elevated. So those losses were with you for a longer period of time.

CONSUELO MACK: Right. And Marty, I have to ask you because in the past when we’ve had you on WEALTHTRACK you were the high-yield bond guru. Here you are. You’ve got a new firm that you founded last year with two other partners, and its goal is investing for income and preservation of capital. What role do bonds have in the portfolios that you’re managing now?

MARTIN FRIDSON: We make some use of them. We have some high-yield bonds. They’re a little bit rich right now, not drastically overpriced but probably would be a bigger portion of our portfolios at some future point when they’re genuinely attractive. We use some corporate bonds particularly short-term corporate bond funds as kind of a liquidity buffer, but the biggest part of our portfolio is our preferreds.

CONSUELO MACK: Preferred stocks. Right?

MARTIN FRIDSON: Preferred stocks. Well, not all of them are actually stocks. We use the term “preferreds” because they’re a variety of instruments where in some cases the underlying asset is actually a bond. A trust has been created that pays out to the preferred holders.

CONSUELO MACK: And what’s the advantage of preferreds? And again, you’re managing money for high net worth individuals. So these are for individuals who are looking for steady income.

MARTIN FRIDSON: That’s right. Well, one of the great advantages of them is that it’s not really an institutional market. A lot of the issue sizes are too small for a big money manager to get involved in. They wouldn’t really be able to buy in big enough size.

CONSUELO MACK: And is that a plus?

MARTIN FRIDSON: Yeah, because there’s less research. You do see some pricing anomalies that come up, so you have an opportunity to buy at attractive levels. We’re not looking to generate high turnover, but we can add some value by buying issues that are just generally underpriced and riding them back up.

CONSUELO MACK: And what about the liquidity issue with preferred securities?

MARTIN FRIDSON: You don’t want to be in a position where you’re forced to liquidate at a bad time. You want to stay liquid enough so that you’re not in that position because the liquidity won’t be great. They can gap down when the market sells off, but we’re able to for the individual investors fill orders if we decide to move into a name. It may take a little bit of time to complete it, but we don’t find that to be an insurmountable problem.

CONSUELO MACK: And speaking of an individual’s market, the municipal bond market is certainly an individual investor’s market. Right?

CHRIS RYON: Yes. You have 42 percent of the market being held by either individuals or by individuals in separately managed accounts. Another 18 percent is held in mutual funds, ETFs and closed-end funds, exiting out money market funds. So that’s close to 60 percent is retail ownership.

CONSUELO MACK: And Chris, how risky is the municipal bond market? Because obviously Puerto Rico has been a major headline recently. How do you analyze it?

CHRIS RYON: Overall the credit in the municipal bond market is improving.


CHRIS RYON: Tax revenues are getting better. States are doing better. Underfunded pensions in some stated have been modified and are getting better as stock returns go up. There are, though, these pockets of highly advertised issues, Chicago being one, Detroit, Stockton, and Puerto Rico being the latest, and you can analyze your way out of those. We don’t own Puerto Rico. We haven’t owned it for years because we felt their debt load has just been unsustainable. Chicago on the other hand has the economic wherewithal to fix their problems. The question is, do they have the political wherewithal to fix them?

CONSUELO MACK: And so therefore, are you investing in Chicago securities?

CHRIS RYON: We’re looking at it closely. Right now it’s a matter of price. But yes. At the right price we’ll be buying Chicago.

CONSUELO MACK: Individuals looking at investing in municipal bonds. Obviously there are the tax advantages. Again, how risky is that market?

CHRIS RYON: You still have credit risk and you have duration risk since price sensitivity changes in yields.

CONSUELO MACK: To interest rates. Right.

CHRIS RYON: And we’re at very low levels of interest rates, so an investor has to be cognizant of the price sensitivity of the portfolios or funds they’re investing in. The other thing an investor has to be cognizant of is how is that fund structured. There are three ways to structure a municipal bond portfolio, especially in the short and intermediate segment of the markets. You could barbell the portfolio which means invest at the extremes of the portfolio’s investment universe. You could …

CONSUELO MACK: So have short-term bonds and long-term bonds.

CHRIS RYON: Exactly.

CONSUELO MACK: That barbell.

CHRIS RYON: Right, and nothing in the middle, or you could bullet the portfolio which means concentrating your investments in the middle of the investment universe, or the method we prefer is to ladder our portfolios.

CONSUELO MACK: And explain what laddering is.

CHRIS RYON: Laddering is that we invest in every segment of the portfolio’s investment universe. So in a one to ten-year fund like our Limited Fund, we’ll invest in every maturity. We’ll overweight the maturities slightly that we think are cheap and underweight those that we think are rich, and over the long term that structure has paid out handsomely, beating the other two structures over the last 20 years by 20 to 25 basis points. It doesn’t work all the time. It works 60 to 70 percent of the time, and that’s assuming you’re right 100 percent on your decisions on when to reweight. As I like to say, if I was in major league baseball and I was batting .600 to .700, first I’d be in line for a drug test and then maybe put in the Hall of Fame.

CONSUELO MACK: So Marty, I’m intrigued by the specializing in income, in steady current income and preservation of capital. What are the different types of securities aside from preferred that you’re looking at?

MARTIN FRIDSON: We also use Master Limited Partnerships and Real Estate Investment Trusts. Within some of the bond categories we’ll look at closed-end funds particularly when you have very large round lot sizes that make it out of the league of our clients to participate in directly.

CONSUELO MACK: And dividend-paying stocks. Right?

MARTIN FRIDSON: Yes. Dividend-paying common stocks are a very important component because what people lose sight of is that if you retire today at 65, you have a life expectancy of more than 20 years. Although inflation has been low by the standards of what a lot of us remember back in the ‘70s, it works like compound interest. So even a fairly low level of inflation builds up so that if you retired 20 years ago with literally a fixed income, say a pure bond portfolio, long-term bonds and the income stayed where it is, you’ve actually lost 38 percent of your purchasing power over that time.

CONSUELO MACK: Wow, but by having this fixed income portfolio that’s not growing with inflation.

MARTIN FRIDSON: Right, and so we think about what that means to your lifestyle. Imagine you go to the golf course and they only let you play 11 holes. That’s how big a hit.


MARTIN FRIDSON: That’s how big a hit it’s been. So you need a growth component, and the dividend-paying common stocks, not the ones with the highest yields today but the ones that have a long record of increasing their dividends and the prospects of continuing to do that without sacrificing too much in current yield on the overall portfolio, you can build in that protection against that erosion of purchasing power over time.

CONSUELO MACK: So that’s a core part of your portfolio are these common stocks with growing dividends. But another mission of yours aside from steady income, current income is also preservation of capital. So here we’ve had a six-year bull market. People have been looking for income vehicles, so I’m assuming that any stock paying a dividend has been looked at and acquired. How expensive, how dangerous are these levels as far as the preservation of capital aspect?

MARTIN FRIDSON: They’re not a big part of it, and these companies are going to be around. Like any other stock, they can rise or fall with the market, but that has to be looked into the total part. I mean if you look at our investors, these are people who are looking to live on their income. Let’s say they have a million dollars in a 401(k) plan. They have to generate $50,000 a year over and above the Social Security income. Buying your growth stocks with one or two percent yield is just not going to do it for them. So they have to look at other vehicles, and they have to be realistic and say we’re not going to have a steady growth quarter by quarter for the next 20 years. There’s going to be some volatility in the portfolio, and if you can accept that you can earn that sort of return in the five to six percent range with a variety of those vehicles that we’ve talked about.


MARTIN FRIDSON: We use them a little bit.

CONSUELO MACK: A little bit?

CHRIS RYON: Use them more.

MARTIN FRIDSON: At this point. Well, we probably will at a future point. We’ve been a little concerned about the volatility, some of the issues that Chris mentioned, but we have them in the short-term area muni funds, and there are certainly a lot of very solid municipalities out there. So if you have some that have some problems, there are many others you can buy that are very sound.

CONSUELO MACK: One of the issues that’s come up in concerns about the bond market is that you hear out there that bond mutual funds are dangerous and that ETF bond funds are dangerous as well because of liquidity issues. So Chris, how dangerous are bond mutual funds and ETFs at this point?

CHRIS RYON: They’re not dangerous at all. It depends on how the manager’s managing these risks. For example, we’ve decided to take our durations into the bearish range because valuations have been on the rich side. To manage liquidity we’ve decided to sit with double- digit reserves. We want to be a liquidity provider when the market has these big disruptions, and we think we’ll be able to provide a lot of value at that time. ETFs are another question. ETFs have been advertised that you are buying them with daily liquidity, and the analogy I like to use is if you have an ugly dog and you put a blanket over it, you still have an ugly dog. So if you have an illiquid market, high yield or municipal bonds, and you put a distribution channel of an ETF over it, you still have an illiquid market. If people want their money back, the ETF just like a mutual fund is going to have to sell bonds to be able to give them money back.

CONSUELO MACK: At the end of every conversation on WEALTHTRACK, we ask for the one investment for a long-term diversified portfolio. So Chris Ryon, what would it be? What should we all own some of do you think?

CHRIS RYON: Well, I’ll be a bit of a homer because I like the municipal bond market. I especially like the intermediate portion of the municipal bond market.

CONSUELO MACK: And intermediate meaning …

CHRIS RYON: Let’s say 12 to 20 years because in that portion of the curve you pick up about 80 to 90 percent of the income of a long municipal bond at about 65 percent of the duration risk. So to me that is, if you’re a value-oriented investor, you’re getting paid to take that kind of risk there.

CONSUELO MACK: Right. And again, a longer-term horizon, and we asked long-term diversified portfolio. That’s kind of the sweet spot now.

CHRIS RYON: That’s what I think it would be, and you have to have at least a five-year horizon for something like that.

CONSUELO MACK: Okay. Marty, what would yours be?

MARTIN FRIDSON: Well, I think every investor who is looking to earn income should have a liquidity buffer in the portfolio, and that might be five or ten percent of the total. We’re not talking about cash. Not talking about Treasury bills but short-term corporate bonds, short-term municipal bonds. You just don’t want to be thrown into the situation where you have to sell at the worst possible time. So if you have that buffer to take care of cash needs that might arise, might be unforeseen, you put yourself in a stronger position to deal with the market over the long run.

CONSUELO MACK: So we’ll leave it there. Chris Ryon from Thornburg Investment Management, thank you so much for being with us for the first time on WEALTHTRACK.

CHRIS RYON: Thank you.

CONSUELO MACK: Thank you so much for being with us, Chris Ryon from Thornburg Investment Management. Thanks for joining us for the first time on WEALTHTRACK and, Martin Fridson, once again. You’ve been on WEALTHTRACK many times over the years but now with a new firm, LLF Advisors. Thanks for being with us.

At the close of every WEALTHTRACK we try to give you one suggestion to help you build and protect your wealth over the long term. This week’s action point is: Diversify your income sources.

Marty Fridson says his job is to be an income analyst, not an advocate, which is why he has switched his focus from what he characterizes as slightly rich high yield bonds to other sources of income, including dividend growing stocks and preferred securities.

Chris Ryon specializes in municipal bonds but he runs diversified portfolios of them and ladders the maturities in his selections to rotate risk and return.

In this record low interest rate environment, fraught with uncertainty, varying your income sources is the safest bet.

Next week is the beginning of the summer fund raising season on public television, so we are going to revisit a popular topic – retirement! We’ll hear from highly regarded financial advisor Jonathan Pond. He has some simple steps to see us through, no matter what our circumstances.

To hear more of our interview with this week’s two investment pros, including Ryon’s assessment of Puerto Rico’s woes and Fridson’s agnostic views on income opportunities go to our website wealthtrack.com and click on the EXTRA feature.

Tagged with:

Back to Top