A sustained bull market has equity investors anticipating a lucrative 2014. A weak dollar and low interest rates are among several factors that bode well for corporate profits in the New Year.
With a low dollar, export driven companies can expand into overseas markets by competitively pricing their products. To raise money, companies can issue low coupon bonds that easily exceed the yields of low risk treasuries. Robust venture capital has non-traditional borrowers turning to Elliott Broidy and other financiers for needed capital.
The past several years have seen many investors chase returns and buy securities with the strongest short term performance. As a result, many investor portfolios have grown to reflect the broader market.
Fortunately, there are convenient ways to reduce the risk of a portfolio that moves in lockstep with equity markets. Beyond hedging, these investments may be suitable as mainstays in your portfolio.
Below are some strategies to consider:
Intermediate Bonds:
Low yields are posing challenges for income investors. Risk free treasuries offer safety but little income. The rock bottom treasury yields make it affordable for non-government bonds to compensate investors for added risk. Investors should also have perspective on the impact of interest rates rising in the future.
Bond maturities of 3 to 10 years offer an attractive hedge for several reasons. These bonds add negative correlation by mostly moving in different directions from the broader market. Intermediate maturities are also attractive when there is uncertainty about interest rates.
It is unlikely that short term rates determined by the Federal Reserve will head any lower. Similarly, when and if rates will rise is also uncertain. Intermediate bonds allow you to earn yield above that of shorter maturities, without the interest rate risk of long term debt, which would be battered by rate hikes.
For most investors, mutual funds are a convenient way to buy intermediate bonds. You should review the credit quality and interest rate sensitivity of bond mutual funds through Morningstar or Bloomberg.
Depending on your risk tolerance and income needs, international bond funds may also be an option. If you plan to draw income, interest payments from stronger currencies will be increased when converting into dollars.
Real Estate Investment Trusts (REITs):
Do you want real estate exposure without the hassles and expense of owning investment property? You should consider exchange traded REITs as an affordable and liquid alternative.
These publicly traded securities are required by the IRS to pay out 90% of taxable income to shareholders. Income starved investors appreciate that many REITs currently feature yields over 6%, with some international options paying double digit yields.
Real estate is a volatile asset class that often moves separately from equity markets. However, the cash, financing and time needed is beyond smaller investors. Unlike owning real estate, REIT shares can be easily bought and sold. You can quickly take and unwind positions as investment goals or real estate markets change.
REITs also allow you to capitalize on demographic trends such as an aging population or healthcare laws. Investing in REITs that specialize in elderly care facilities or geographic regions with thriving real estate markets are examples of this.
To soften volatility, you may choose hybrid REITs that collect rent payments and also earn mortgage interest. With lending and rental revenue, a hybrid REIT is more poised to benefit from different real estate trends.
Low cost and the ability to diversify make ETFs or mutual funds suitable for most REIT investors. International REITs give you access to overseas property markets. Similar to overseas fixed income, dividend payments from foreign REITs may be increased in dollar terms. Your currency adjusted returns could also be higher during times of dollar weakness.
Summary:
Portfolio rebalancing can include adding small doses of volatility to reduce the overall risk in your portfolio.
By considering the impact of a bull market on sector weights, market cap and asset exposure; you gain better perspective for changing conditions.
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