Low Yield Market Dilemma

A year ago, ultra-low interest rates was supposedly meant to be a temporary measures, but it has persisted for so long now and if you are fixed-income investors, it will be a key challenge for all of us in 2010. Can we expect short-term rates to move higher anytime soon?

Long term interest rates may drift higher due to worries about US’ rapidly growing deficits and the potential for inflation down the road. But it remains quite unlikely to see short-term rates heading anytime higher soon. In fact, Fed’s most recent policy statement, they fully intend to keep rates ‘at exceptionally low levels ..for an extended period’.

It is a great dilemma for this generation and possibly the generations that come after me. Given this situation, I may have to work past my retirement age, not because I loving every minute of it. Just think, how difficult it is to cope with the triple whammy of potentially rising inflationary pressure, low yields and plus falling dollar.

I talk to a lot of people lately, but many don’t know what to do with this and many are taking on significantly more risk to make up for low yields. They are investing in higher risk stocks and other growth investments hoping to improve their cash-flow. And that is the real problem, but what choices do we have?

Do you know that in-spite of the headline-grabbing rally in stocks over the past year, government and corporate bonds have actually performed better than stocks over the past 12-months through the end of September. The key trouble is that most investors don’t own enough bonds to help stabilize their investment mix. According to a fund manager that I know quite well, investors own four times as much as in equities as in fixed income securities today.

Not all bonds or bond funds are created equal. Different types of bonds have different sensitivities to changes in interest rates and credit conditions. I note that many people make their own investment decisions rather than use an advisor. I wonder how they differentiate among the many bond funds in all different areas of the fixed income universe. After all, there are thousands of it and millions of bonds the world over to choose from today.

Now, I am slowly moving to manage my bond funds more actively, something that I never take it too seriously before. I am constantly reviewing, restructuring my portfolio to earn extra income and reduce risk, including paying more attention to emerging market bonds to protect me from falling US dollar scenario, and Treasury inflation protected securities (TIPS) with duration concentration in the shorter-to-intermediate range – 2-10 year range, indeed, which generally tend to have low or even negative correlation with stocks.