20
As most equity markets surged to record highs in
2013
, the summer sun burned the bond market. The
prospect of the Fed tapering its purchase of bonds
sooner than expected rattled the market in May, and
many fixed-income sectors took it on the chin during
the summer months and haven’t fully recovered.
Among the worst-performing areas of the market
were inflation-protected and municipal-bond funds,
as other factors specific to those sectors further exac-
erbated the losses from the broader sell-off. Given
that backdrop, and drawing on inspiration from Russ
Kinnel’s annual “Buy the Unloved” approach to the
equity markets, there’s a case to be made for a buying
opportunity in those areas. Both categories experi-
enced significant outflows in
2013
, to the tune of $
29
billion out of inflation-protected bond funds (
25%
of
category assets) and $
58
billion out of the overall
municipal-bond fund universe (
10%
). Indeed, investors
hitting the exits in droves were themselves a contrib-
uting factor to the categories’ weak performances, as
fire sales in the midst of the sell-off put additional
downward pressure on prices in those two relatively
illiquid markets.
That was particularly true of muni-bond funds, where
mutual funds are big players in the market and the
selling pressure significantly affected pricing. What’s
more, the Detroit bankruptcy filing and turmoil in
the Puerto Rican debt markets weighed on returns
and caused additional bouts of volatility. Funds in the
muni-national long and high-yield muni categories
were hit the hardest, but all U.S. municipal fixed-
income categories lost money in
2013
. Sell-offs often
create opportunities, though, and as of late, municipal
bonds have looked very cheap relative to Treasuries
on a historical basis. See the chart on the facing page.
Factoring in the tax benefits of owning munis, mean-
while, may make this an opportune time to add
exposure. While there may be additional future vola-
tility in the market and munis do have interest-rate
sensitivity, there are several funds that may be a
good fit for those with a long time horizon. The team
from Fidelity, led by veteran Mark Sommer, offers a
straightforward and careful approach to the muni
markets via Gold-rated
Fidelity Municipal Income
FHIGX
and
Fidelity Tax-Free Bond
FTABX
. These
funds eschew leveraged structures and tread care-
fully in the muni market’s diciest names, which has
given investors a relatively smooth ride and solid
returns. Vanguard also provides relatively conserva-
tive exposure to the muni market at rock-bottom
prices through its family of tax-free funds, including
Silver-rated
Vanguard Intermediate-Term Tax-
Exempt
VWITX
and
Vanguard Long-Term Tax-
Exempt
VWLTX
.
Even when after-inflation (real) yields on Treasury
Inflation-Protected Securities turned negative in
recent years, many managers still argued that expec-
tations for the eventual onset of inflation justified
keeping money in the category, particularly over
comparable Treasury bonds. As of Dec.
31
,
2013
,
the backup in rates meant that after-inflation yields
across the curve landed in positive territory, while
inflation-expectations—derived from pricing differ-
ences between
TIPS
and conventional Treasuries—
remained below the historical average. For example,
pricing differences at year-end implied an expected
rate of inflation of
1
.
7%
during the next five years.
If one believes that inflation will be higher than
1
.
7%
annualized during the next five years, now may be
a good opportunity to invest in an inflation-protected
bond fund.
TIPS
offer an explicit link to inflation
and can play an important role in a diversified port-
folio. Proven funds worth considering here are
Gold-rated
Harbor Real Return
HARRX
and
PIMCO
Real Return
PRRDX
, both of which are managed
by
PIMCO
’s head of real-return portfolio management
Mihir Worah. For cheaper and more benchmarklike
exposure,
Vanguard Inflation-Protected Securities
VIPSX
is another solid option.
œ
Contact Michelle Ward at
Munis and TIPS Beckon
Income Strategist
|
Michelle Canavan Ward
