VWEHX
Safety First
As investors get optimistic, riskier assets tend to outperform. As they get more pessimistic, safer assets tend to win. While there were some big ups and downs in the stock market in 2007, the real fear was in the bond market - the place where real estate bubble borrowing goes to find a buyer.
In 2007 investors started to question the likelihood that all these trillions in borrowing would get repaid. What started in real-estate-related debt moved to all consumer debt and even lower grade corporate borrowing. Where did all this newly conservative money flock? Good ole' Uncle Sam debt. That's right - capitalists favorite whipping boy, the government, is the investment of choice when the going gets rough.
Look no further than Vanguard for an indication how the bond market was in 2007. Vanguard Long-Term U.S. Treasury (VUSTX) was up 9.2%, while Vanguard High Yield Corporate (VWEHX) was up a paltry 2%.
But the real winner in 2007 was bond king Bill Gross, who's negative outlook on the economy and general suspicion of the fancy financial footwork in the housing market led his bond funds to a strong return in 2007, after a ho-hum 2006:
The Pimco Total Return fund that Gross runs scored a gain of 8.6% last year, a higher return than 90% of its peer bond funds -- and better than the 6.4% gain of the average stock fund -- after Gross' gamble that the housing crisis would force the Federal Reserve to cut interest rates paid off late in the last third of the year.
For the fourth quarter, Gross' fund returned 3.8%."
We've had a long-time Powerfund Portfolio holding in Bill Gross-managed Harbor Bond Institutional (HABDX), which was up 8.7% in 2007.
Where Can A Yield Hungry Fund Investor Go?
The current financial turmoil has lead to a series of unfortunate events for investors looking for safe yield. To bail out a sliding economy and housing market, the Federal Reserve is lowering interest rates to rock bottom levels, which shrinks yields paid by money market funds, CDs, and short-term bond funds. Panicked investors have bought government bonds down to pathetically low yields - 3.5% on the ten year, far less on shorter maturities. To make matters worse, these yields, after tax, are below the rate of inflation. This leaves the yield hungry between a rock and a hard place (and rock prices are rising).
A BusinessWeek article notes some options:
We'd add that investors might have to take on even more risk. Funds that write covered calls can generate attractive yields, albeit with far more risk than most bond funds but less than ordinary stock funds. High yield (junk) bond funds like Vanguard High-Yield Corporate (VWEHX) yield about 8.6%, now rewarding investors quite a bit more than safe debt yields for the heightened risk (even though such funds have 20% downside risk in a bad market for low-grade debt). Even stock index funds are looking attractive (thought with much higher risks than most bond funds) given the 2.37% yield on the S&P 500, which actually beats some bonds adjusting for the tax break on dividend yield. One strategy could be to start buying these higher risk / higher yield funds now with a relatively small portion of your portfolio, and if the credit markets and economy worsen, increase your stake further.
Be warned that reaching for extra yield can be dangerous (as all the hedge funds and other investment partnerships buying mortgage debt with leverage are finding out). Of course long haul, earning less than inflation is dangerous as well.
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