Dec 23, 2022
Bond Series 4
How NPF manages our bond portfolios to navigate these difficult markets.
Many investors get their bond exposure through mutual funds, which has seen tremendous price weakness in the current market environment. Essentially, these investors in bond funds are forced to ride the waves as the portfolio of bonds gets repriced in the market daily (the “Net Asset Value”) based on the whims of the market sentiment. Unfortunately, if you need to take money out of the fund during these times, you’ll take a haircut (possibly substantial) on the value of your interest in the fund – as you would sell at your pro-rata share of the current value of the holdings.
But what if there are bonds in the portfolio that are trading at good prices relative to other bonds?
Why not sell those? Or could you sell individual bonds that are close to maturity and would provide you cash to cover your current needs in the near-term? Unfortunately for the mutual fund investor, those holdings are used to help provide cash for those redeeming their interest in the fund (the cash has to come from somewhere), but the value you get per each share you sell is still at that discounted, Net Asset Value. This problem is exacerbated in markets where many people or selling their bond fund holdings – forcing the manager of the funds to sell the good, liquid bond holdings, and leaving the remaining investors in the funds with less-liquid, often lower-quality holdings.
The experience many owners of bond mutual funds are dealing with today is why NPF has always preferred to purchase individual bonds for our clients.
By owning individual bonds, an investor owns bonds that align with their known circumstances. For example, if an investor knows they need $50,000 for a new car in the next couple of years – a bond can be purchased which aligns roughly with the known expenditure. No need to sell the bond fund down 15%, we just let the bond mature and buy the car with the proceeds. Don’t need to spend the money from a matured bond? No problem. And like we are experiencing now, we would then be able to invest at higher rates – a good thing in our mind, and why we structure maturities in the portfolio to take advantage of different potential paths for interest rates (i.e., buying shorter maturities to benefit from higher rates, or buying floating interest rate bonds to benefit when rates go up).
Cash flow timing is not the only way to customize a bond portfolio for a client.
Taxes, credit quality, and many other factors can be utilized to build a portfolio that meets your individual circumstances. For example, by knowing your tax situation, we know when it is appropriate to buy tax-free bonds in a taxable account, or when you are better off buying taxable bonds and paying some tax on it (i.e. when you are in a lower tax-bracket, or when tax-free bonds are selling at a premium relative to taxable bonds). We also help determine when it is appropriate to take calculated risks on certain bonds to improve the total potential return versus when your primary goal is capital preservation, and we want to minimize credit risk.
Ultimately, it’s like a tailored suit that we want to fit exactly to your specifications.
A bond fund can provide easy access to the fixed-income asset class, but it is a “mass market” vehicle – not managed for you but managed for a pool of investors. You’ve worked hard for your wealth, and we believe that you deserve a portfolio designed to work the best way for you. To learn more about how NPF can assist you with bond portfolio, please feel free to contact us with any questions or comments.