Midland Asset Management, Dallas TX, a Fee-Only Financial Planning Firm, Releases its Process of Bond Management
Midland Asset Management releases its process of bond management, an often misunderstood issue, but an important strategy for allocating investment assets to bonds.
(PRWEB) May 18, 2007 -- Midland Asset Management releases its process of bond management. At this critical junction in the economic cycle, Midland Asset Management believes this information is pivotal.
The focus for any bond investor can best be summarized: "The primary goal of a laddered bond portfolio is to achieve a total return over all interest rate cycles that compares favorably to the total return of a long-term bond, but with less market price and reinvestment risk." Source: TIM
Historical Perspective
During the late 1980's and 1990's, investors owning municipal bonds or municipal bond mutual funds with long maturities (greater than 10 years) enjoyed gains averaging over 12% per year. However those periods were when the Federal Reserve was reducing interest rates - consistently. On the opposite end of the spectrum was the decade of the 1950's -- considered the worst decade for owners of long-term bonds with investors experiencing an average annual loss of -0.1% (with re-invested interest income).
If one owns a bond with a long maturity one needs to know what the expected interest payments over the life of that bond. The price of any bond is the present value of this stream of interest payments discounted at current interest rates. As rates fluctuate, the present value of this stream of payments constantly changes. Below is chart showing the difference in average rates of return and the riskiness (standard deviation) of the bond.
Summary Statistics of Annual Returns
1962-2001 Average Annual Total Return Standard Deviation of Return
Treasury Bills 5.96% 2.61%
5-Year Gov't Bonds 7.33% 6.58%
20-Year Gov't Bonds 7.08% 11.44%
Source: Ibbotson Associates
One will notice that Intermediate bonds, defined as those with a maturity of five years, had higher total returns with almost half the risk (standard deviation) of long-term bonds.
Midland's Process to Managing Municipal Bonds
Midland believes laddering provides a municipal AAA bond portfolio with staggered maturities so that a portion of the portfolio will mature each year. Laddering tends to outperform other bond strategies because it simultaneously accomplishes two goals:
| | - Captures price appreciation as the bonds age and their remaining life shortens
- Reinvests principal from maturing short-term bonds (low yields) into new intermediate bonds (higher yields)
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However Midland also reviews certain issues that are special to the municipal bond itself. Midland feels those issues can be captured in the table below. As one builds a municipal bond portfolio, Midland's process weeds out the bonds which are window dressed by investment bankers to look good but peeling off the cover reveals a bad stench.
Risk Control Strategies
Risk Solution
Credit Risk Careful selection, diversification, ongoing credit review
Income Tax Risk Municipals and tax-deferred
Market Price Risk Compromise
Re-investment Risk Compromise
Source: TIM
Midland believes since the Federal Reserve, Hedge Funds and other soothsayers on Wall Street cannot predict where interest rates are going in the short, intermediate or long-term Midland will not either. What is point of paying someone to guess? Midland's focus is to build a portfolio of municipal bonds which provide stable income and to provide the bedrock for one's overall investment portfolio.
Looking at any highly rated municipal bond fund one can observe the drastic changes in its price. The aim of a laddered municipal bond portfolio would be to smooth out the changes in value and to create a stream of interest payments to match one's income needs. Mutual funds or money managers don't have the time or ability to match one's needs specifically. At Midland Asset it is the focus for one's income needs to be matched with one's income goals.
For more information, please visit http://www.midlandasset.com.
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