SO YOU HAVE DECIDED TO BUY BONDS. HERE ARE SIX CHARTS SHOWING TOUR OPTIONS / THE WALL STREET JOURNAL

So You Have Decided to Buy Bonds. Here Are Six Charts Showing Your Options.

Plain-vanilla Treasury bonds are now pricey, but there are alternatives

By Jon Sindreu

With deposit rates starting to slide below 4%, and 10-year Treasury yields rising above that rate for the first time in two months, you may want to shift from cash to fixed income before it is too late. 

Thanks to traders becoming more realistic about interest-rate cuts, Treasurys are now offering a return that is clearly above the Federal Reserve’s long-run interest-rate expectations. 

This may be enough for income-minded investors, but there isn’t a huge scope for capital gains.

It may be time for less-obvious strategies.

Look further down the Treasury curve

Many may balk at the thought of buying a 20- or 30-year Treasury, which yields only 0.3 percentage point more than 10-year paper but carries greater risk of price fluctuations. 

Indeed, long-term debt has lost investors money since the Fed ended its tightening cycle in July of last year as long-term rates have drifted higher. 

But the current experience isn’t typical: Between 1980 and 2020, monetary-easing cycles did lead to steeper yield curves, but in almost every case long-term yields fell—it is just that short-term ones fell more. 

During these rallies, 30-year Treasurys delivered higher returns than either two-year or 10-year debt in every single case. 

This includes 1995, which featured economic conditions similar to today’s. 

As the Fed keeps cutting, history may yet repeat itself.

Corporate debt has been bid up, but opportunities remain

Investors have gobbled up the investment-grade debt of blue-chip companies this year as it offers a 0.8 percentage-point pickup over Treasurys. 

But this spread is at a near-record low, compared with a median of 1.3 percentage points over the last 15 years.

To be sure, the median spread was 0.9 percentage point before 2008. 

Even if corporate-bond fund managers believe this is too tight, periods of high yields drive many investors to just keep giving them money, which needs to be deployed. 

This is what is happening right now. 

Firms have also massively reduced their net debt since the 2008-09 financial crisis, and default rates have remained relatively low despite higher borrowing costs.

Still, investors have been particularly negative about “junk-rated” issuers in the consumer noncyclical sector, which trade at a discount to usually riskier cyclical companies such as hotel chains. 

This is a rare phenomenon and may spell opportunity since “defensive” industries usually do well in rate-cutting cycles. 

The BondBloxx USD High Yield Bond Consumer Non-Cyclicals Sector ETF, for example, has a yield of 6.3% and owns firms such as drug retailer Walgreens Boots Alliance and KFC-owner Yum Brands.

Play the acronym game

Whenever rates are coming down, eschewing floating-rate instruments such as collateralized loan obligations or CLOs—bundles of leveraged corporate loans—seems like a natural choice. 

But, as always, price is everything. 

Right now, their discount relative to short-maturity investment-grade debt has widened considerably, and even AAA-rated, safer CLO investments offer yields above 6%. 

Since 2020, individual investors have been able to gain access to them through vehicles such as the Janus Henderson AAA CLO ETF.

Were interest rates to fall more than expected, these CLOs would probably still do well: When the Fed eased policy after 2018, they ended up performing roughly in line with equivalent fixed-rate bonds, thanks to higher starting yields. 

Nevertheless, those committed to locking in long-term fixed yields could look into mortgage-backed securities, or MBS, that have the backing of U.S. government agencies, which are very low risk. 

They offer a 0.4 percentage-point pickup over Treasurys, while the median of the past decade has been 0.3 percentage point.

Don’t forget to shop abroad

Emerging-market debt is another great beneficiary of Fed rate cuts, but hard-currency bonds are trading at their priciest relative to U.S. debt since 2018, which in turn was a record outside of the “Brics mania” of the 2000s. 

Bonds issued in local currencies have become a deeper, more resilient market in recent years, and currently offer yields of 16%. 

The catch here is the exchange-rate risk: For 15 years, investors have consistently suffered from these currencies depreciating against an ever-stronger U.S. dollar. 

But the greenback now looks historically expensive, and most of these nations are expected to keep rates high in the foreseeable future. 

This could create a window of opportunity.

Or investors could just go to Britain, where bonds offer similar yields as in the U.S. 

The difference is that the economy there is likely to grow at a slower pace, which should eventually force the Bank of England to stop being so hawkish. 

Yet sterling will probably remain supported by the many international investors who are returning to the U.K. after years of shunning the country following Brexit.

What about bond proxies?

If bonds are looking too stretched for comfort, investors can always get their income through dividend-paying equities. 

Rather than just picking companies with the largest payouts, however, the best approach has historically been to screen for stocks with both high dividends and low volatility. 

Over the past two decades, this strategy has generated returns on par with the technology-fueled S&P 500 with a risk profile that is somewhat closer to that of bonds. 

Investors dumped these stocks after the pandemic, shocked that so many companies scrapped dividends, but they have jumped back in since the summer.