Wild and Woolly World of Bonds

Obviously fixed income vehicles like bonds with regular interest income payments are the easiest asset class to squeeze out a steady come. I read someone on SeekingAlpha say 

"Holding stocks, you are waiting for your horse to win the race whereas holding bonds your horse merely has to finish the race".

Ardennes warhorse superior to racing breeds for everyday

Although the above sentiment is not quite right in boom times as a rising tide lifts all boats (investing is full of conflicting cliches), race horse analogy does hold more water for the more challenging economic times.  I'm not going get too ambitious in a late cycle environment and rely more on fixed income. Also in the worst case, bond holders are paid before preferred stock before common- of course who knows what happens to Tesla bond holders if things do go belly up. I digress.

Bond and fixed income markets are even more diverse than the equity market and there are multiplicity of options to invest in the bond sector. I just know the basics to navigate and evaluate a bond fund with a surface understanding of the basic credit risk and duration risk that I picked up from investopedia.

Buying bonds directly(with the exception of treasuries and preferreds) in this interest lowering environment has been not worth the effort for me. For instance, new municipal bonds are less than 1.5% right now- BART released an insulting 1% 3 year bonds last week but I guess we should be grateful rates are not negative like most of Europe and Japan.  For ease of investing, liquidity and higher rates, I hold high quality bond ETFs and mixed bond CEFs. The advantage of muni bond funds with long durations is that they are hoarding those precious 30 year 5% interest bonds from that bygone era(a soft flute plays) and can payout much higher yields.  Obviously all munis funds have increasing call risk and will have to replace in this low interest rate environment.

 Bonds currently have the following pitfalls:

• bond bubble- yes, too many people have piled onto anything dishing out a yield
• even "safe" treasury backed bond ETFs carry significant price risk, see below chart
• higher yield can mean significantly higher risk without a risk premium to match.  Corporate high yield definitely is a no go zone for me.  5.3% for a corporate junk bonds (HYG, JNK)? No Thanks!  If my quality Muni CEFs are yielding 4.5%, is 80bp worth the leap in risk. Of course not. But even investment grade corporates IMHO carry a higher risk due to BBB downgrade risk.  A few junk bonds in Europe are starting to go zero which is madness.

OMG U.S. Treasuries?
Run up on TLT(2.4% yield on 20 Year Treasuries).
Safe bond fund bubble of unnatural proportion?

Firstly, low yield is NOT ALWAYS to be dismissed as you can hold bond funds for price appreciation as seen in this spectacular example.

TLT(twenty year treasury EFT with 2.23% yield) has had a dangerous run up but if rates go to zero as many hedge fund managers have predicted, can the rally last last longer?  An Austrian century bond paying 2% rose 60% in price this year.  This is where having the original treasury is significantly lowers risk as you will not lose money when you hold it to maturity.

I am currently in short term treasury ETFs and corporate ultra-shorts to park some of my money.

Where to find reasonable yield in a sub-2% fed interest rate environment without being forced too far out on the risk curve?  I've opted for holding Closed End Funds (CEFs) in the municipal space since they use leverage of upwards of 40% to increase yield and give 4+% dividends.   The leverage risk in a falling rate environment is more tolerable to me than trying to get yield elsewhere in corporate space.  I'll have to cover CEFs in another post as there is an art to buying when it goes on a sale and increases the discount.

What's this stock that recently beat the S&P 500 SPY in blue?
PCQ- California muni CEF again.
Sold it regretfully in April since it has an irrational 40% premium.

Here is my brief run down on the various bond categories:

• govt
• short-term  
• actual bonds from the Treasury - not purchasing any more short-term currently as the rates are not favorable compared to the ETFs/CEFs
• ETFs (VGSH,SHY) -  I use them for safely parking money and for their liquidity.  Definitely these have moderate run ups I'm cautious when adding any more.
• long-term ETFs(TLT) - there is currently a ferocious long duration treasury bubble so I am avoiding them
• floating rate(USFR) - bought them early in the year when interest rates were going up but I traded them after Jay Powell turned dovish. However I made the mistake of going into short-term instead of  transferring into long-term treasuries. Floating rate definitely not a good choice in a rate declining environment.
• TIPs - I'm on the fence on their effectiveness and they have always underperformed the other categories for me.
• municipal funds- currently my favored bond category of choice and will write more about them. Yes there is potential pension default risk looming but that steamroller is much slower moving and IMHO will arrive later than the other risks.
• national
• state - long California
• high-yield- junk munis are my guilty pleasure since muni junks have lower default rates than corporate. Also, most CEF munis always contain a percentage to boost earnings.  Blackrock recently voted in changes to allow for high yield muni in "Quality" rated muni funds so it may not be possible to avoid them.
• corporate 
• ultra-shorts (GSY, VCSH, NEAR,MINT,JPST) currently yield 2.5-2.8% which I use for parking money. Risk premium is definitely not enough to eke out less than 50bps and if there are further fed rate cuts reducing yield, I'll definitely dump these.
• high quality
• QLTA has only A rated bonds and it's now overvalued on my watchlist for next time
• investment-grade - currently avoiding unless ultra short due to looming triple BBB downgrade threat
• high-yield- a no-go zone
• senior loans/floating rate loans - avoiding right now
• agency
• MBS(mortgage-backed-securities)- dipping a toe in, will update later

Bonds are a more complex space than equities and has a wide spectrum of risk to match.  However the interest rate/default/leverage risks I personally find to be tolerable in the municipal bond CEF space than holding defensive equities for dividends.