In this white paper, Asset Dedication’s Stephen J. Huxley, PHD, Brent Burns and Jeremy Fletcher present a new concept in financial analysis based on the long term behavior of equities. Click here to read the white paper >>>
For a supposedly boring investment, bonds have shown their capricious side lately. The bond bull market, widely thought to be sputtering out last year, has roared on in 2014. This year’s rally has left even the most seasoned fixed-income investors scratching their heads—and older investors in a challenging spot. Read the article here >>>
In this morning briefing on alternative investments in charitable plans, Kevin Noblet references Asset Dedication’s article that talks about how the three largest unconstrained bond funds haven’t kept up with the performance of the Barclays U.S. Aggregate Bond Index since the beginning of the year. Read the article here >>>
In May of 2013, a small rise in interest rates highlighted the risk that bond fund investors face in their “safe” investments. The relationship between interest rates and market risk is clear. The mathematical relationship is straight forward. When interest rates rise, the value of bonds goes down. For bond funds, rising rates means that total return has to fight the headwind of losses on the underlying portfolio. As NAV declines, coupon interest generated by the bonds in the portfolio may or may not be enough to overcome the price loss. On the other hand, making the same fixed income allocation to high quality individual bonds and holding them to maturity is a clearly superior strategy when rates rise because it can protect principal and avoid losses in a way that bond funds cannot. Download the white paper >>>
Municipalities can sometimes lower their borrowing costs by purchasing bond insurance. In exchange for making payments to an insurance company, the bonds receive the rating of the insurer rather than the issuer if the insurer’s rating is higher – and this means that the municipality can pay a lower yield and save money. Before 2008 most bond insurers were AAA-rated, making this an easy decision for issuers and a lucrative income stream for the insurers.
Assured Guaranty Municipal Corp. (AGM) is currently the larger of only two municipal bond insurance companies still writing new business. Municipalities are cutting spending wherever they can and are generally issuing fewer bonds. This will continue to decrease AGM’s revenues. AGM is also an affiliate of a larger insurance company which was also in the mortgage guaranty business. Moody’s downgraded AGM’s affiliates due to the continuing slow recovery of the mortgage business, though all remain at the “investment grade” level.
With AGM’s affiliates downgraded and its own revenue stream crimped, Moody’s essentially had no choice but to downgrade AGM two notches from Aa3 to A2 – still investment grade. Any municipal bonds AGM insures were also automatically downgraded unless their own ratings remained higher than AGM’s new rating. The downgrade therefore does not imply any negative change in the underlying ratings of the bonds themselves, only that the insurer’s rating has declined.
AGM was one of the largest insurers of municipal bonds and some of those bonds may be held by your clients, either from our purchase in an Income Portfolio or as pre-existing holdings. We are recommending that each bond insured by AGM be monitored on a case by case basis but, in light of the circumstances, no “wholesale” action is needed at this time. If we feel that any individual bonds owned by your clients require action, we will notify you by e-mail along with a recommendation specific to that bond based on its position in the client’s overall portfolio.