Date: 9/14/2010
Author: John Radtke

Five Ways to Reallocate Bond Portfolios

Many advisers looking to diversify holdings of long-duration government bond funds are asking: ‘Where next for yield-thirsty investors’?

Rather than move down the credit curve or take on more duration risk, viable strategies include selecting individual bonds, structured notes and CDs with defined maturities.

The following five ways offer alternatives to often-recommended yield-enhancing strategies such as bond ETFs, dividend-paying stocks or TIPs.

  1. When customizing portfolios with individual securities, consider the 10-20-30 rule of thumb for diversification:
    • When investing in individual corporate and municipal bonds, allocate no more than 10% in any single investment grade municipal or corporate issuer. Exceptions in exceeding this guideline would include FDIC insured CDs and US Agency securities. For non-investment grade issuers, however, a single issuer might represent less than 3-5%.
    • For municipal bonds, allocate no more than 20% of portfolio in any geographic region (within a state or nationwide). This guideline is subject to the relevant state income tax given an investor’s tax bracket. For investment grade corporate bonds, allocations might be limited to 20% in a single industry sector.
    • To reduce reinvestment risk, no more than 30% of the total portfolio should mature or be callable in any single year.
  2. Consider using callable step-up or range accrual notes as alternatives to bullet bonds. Most of these securities offer graduated step-up yields, while typically being callable at the issuer’s discretion. Freddie Mac typically offers a range of maturities on a weekly basis, as do several well-capitalized banks. Callable munis also offer potential yield enhancements, while taking on call risk.
  3. Consider a hybrid barbell approach with a short term liquidity-generating component (such as a ladder of 1-5 yr CDs, corporate or municipal bonds) and a longer term yield-generating 10-15 year ladder of corporates or munis. This technique gives the investor frequently maturing funds to reinvest, while locking in higher yields further out the yield curve.
  4. In retirement oriented portfolios, consider new issue corporate and US Agency note programs which contain a survivor’s option estate feature. This feature enables heirs to ‘put back’ bonds to the estate at par.
  5. Consult the TRACE system prior to buying secondary bonds. With most bond trades being posted within 30 minutes, is an excellent source for price history for secondary bonds.

While buying long term Treasury funds has been a good strategy in recent years, better opportunities for income and capital preservation are likely to be found in a wide range of asset classes and customized portfolios.

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