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What’s Happening In The Fixed Income Markets Right Now?

We’ve seen lots of volatility in the equity market, but what about Fixed Income investments? Blerina Hysi explains what’s happening and what it might mean for your portfolio.

 

Transcript

Tim Maurer:
Tim Maurer back with another episode of Ask Buckingham, a new video podcast designed to bring clarity in the midst of confusion by connecting your great personal finance questions with straightforward answers from industry thought leaders.

Tim Maurer:
Today’s question will be answered by Blerina Hysi, fixed income trading manager at Buckingham Wealth Partners. And Blerina, stocks and oil seem to be getting most of the attention in the midst of the COVID-19 crisis due to the extreme volatility we’re seeing there, but we don’t want to forget about bonds and fixed income. What’s happening in the bond and fixed income markets right now?

Blerina Hysi:
So Tim, fixed income definitely saw its share of volatility, especially in March. It is a little bit harder to put all fixed income under the same umbrella as certain types of fixed income do behave a little bit different than others. That’s where we go into different types of credit quality and how they’re going to act in volatility, but for the most part we did see some volatility overall in fixed income back in March but things seem to be stabilized at this point.

Tim Maurer:
Okay, interesting. Let’s talk a little bit about these different types and credit quality. Maybe start by defining that phrase, credit quality.

Blerina Hysi:
So credit quality refers to the ability of a bond issuer to pay the bonds that they have issued. There are many types of bonds and each one holds a different credit quality. One of them will be treasuries, for example. Those are backed by the federal government. The federal government is held to the highest standard with the likelihood of those bonds being paid being extremely high. Then you have municipal bonds that are paid by each different municipality. And there we get into different types of munies that are each going to hold a different credit quality level. You have what’s called a general obligation bond, those bonds are paid by property taxes.

Blerina Hysi:
When you’re talking about bonds that are getting paid by property taxes, again, the likelihood of that bond being paid is a lot higher than if you’re comparing it to what’s called a revenue bond. And revenue bonds have different nuances too. You could have what’s called an essential purpose revenue such as a water sewer, which is obviously going to be higher than a revenue bond that’s based on a stadium bond or an airport bond, and especially with what’s going on with COVID-19 for example. Let’s focus on an airport bond. We’ve seen airlines really struggle with the fact that nobody’s firing, just losing a lot of revenue in that sense. That is going to affect all these municipal bonds that are deriving their revenue from the airport because you don’t have that flight inflow and outflow. There’s no taxes being charged on each ticket, therefore there’s no revenue to come into the bond issuer to pay these bonds. So obviously that kind of bond would struggle a lot more than a water, sewer bond. Water, sewer bonds will be paid prior to what’s called a non-essential service bond. And even when you’re talking about the generalization of a general obligation or a revenue bond, essential or non-essential, there’s different categories as far as that goes.

Blerina Hysi:
Not one municipality is going to be similar to another. Keep in mind where California is doing great job at containing COVID-19, New York isn’t. So when you’re thinking a general obligation of New York, it could potentially affect the credit worthiness of that general obligation because it is hitting New York so hard versus another state that has done a good job at containing COVID-19 will not see as much of a struggle. So those are all things to consider when you’re talking about the fixed income market and how it’s being affected in general during volatility, as well as for the specific issue of COVID-19 and how that’s affecting each municipality.

Tim Maurer:
Sounds like there’s a lot more complexity and nuance to this whole fixed income market than most would presume. In fact, I think the general presumption is that bonds are bonds, and bonds are safe. But it sounds to me like there are varying levels of safety. Could we talk maybe specifically about treasuries and then corporate bonds? I think the two that people are most familiar with, and the degree to which the investors in those bonds can feel safe.

Blerina Hysi:
Absolutely. And that is one of the biggest misconception when you consider all bonds to be safe. As I mentioned earlier, there’s so many nuances to bonds. So treasuries are considered the safest bond out there. Obviously, if we had issues with the federal government paying their bills, we will be in much bigger trouble.

Blerina Hysi:
To our corporates, they are deriving the ability to pay these bonds from the revenues they bring from their business. So depending on the type of corporation you’re looking at, some are going to struggle more than others depending on what’s going on with the market, and specifically with COVID-19. There’s bonds that are based on hospitality for example, those, we will see a major struggle in. Airport bonds, we’ll see a major struggle with COVID-19. All these bonds that don’t have that steady stream of revenue in the corporate world will definitely see some issues with the ability to pay these bonds and that’s going to reflect in heir credit quality as well as the way they trade. Obviously there’s going to be some price risk into it.

Tim Maurer:
So fascinating. So if I’m hearing you correctly, if you own corporate bonds, perhaps even household names that everybody is familiar with, you’re saying that when stock markets get volatile, those very same corporate bonds with household names could be experiencing something similar to the volatility in those stocks?

Blerina Hysi:
Yes. So if you think about it, the stock market is comprised of stocks of these bigger companies. If something is affecting the stock market, it will affect the bond market as well. High grade corporates do behave a little bit better than high yield, but high yield is where you’re going to see the grunt of this negative return during downturn markets.

Tim Maurer:
So what is the practical takeaway here, Blerina? What does the everyday investor want to think about when they’re putting together the bond portion of their portfolio?

Blerina Hysi:
So what they need to focus on is truly having a safe bond portfolio. Just because you have bonds in your portfolio doesn’t mean that you are protected. And by safe, I mean you want it to be as different as the equity portion. You want it to have the ability to dampen the volatility you’re taking on the equity side. If you want to get higher rewards, you have to take higher risks and you do that by exposing your portfolio to the equity side. On the other hand, have your fixed income dampen that volatility and focus on super high grade fixed income, and that’s going to be your treasury, that’s going to be your municipal bonds, or what we typically focus on is brokered CDs, which are all FDAC insured.

Tim Maurer:
Wow. So this makes a lot of sense. If you want to make money, invest in stocks. Then when you look to your bond portfolio, you want to find the stablest of the stable in order to balance out your portfolio so that when stock volatility gets crazy, you’ve got something to keep the ship afloat. Is that right?

Blerina Hysi:
That’s correct. Don’t look to make money on your bond portfolio. Bonds do cap you when they mature, they mature at par, so you don’t have the ability to have that unlimited upsides as you would with the equity side.

Tim Maurer:
Well, thank you so much, Blerina, and thank you for tuning into this episode of Ask Buckingham. If you have a question that you’d like to see us address, you can do so by navigating to the website, AskBuckingham.com, or by emailing your question to question@AskBuckingham.com, or just click in the corner of the screen it’ll take you directly to the website.

Tim Maurer:
Remember that there are no dumb questions, but unfortunately there are plenty of poor answers out there. Our hope is that in giving you straight answers to your questions, it will bring a sense of calm and allow you to apply what you’ve learned in pursuit of good decision making. So please follow us. And by all means, Ask Buckingham.

 

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