| Bond Management Our philosophy in the management of our fixed income portfolios is to provide a real rate of return in any market environment. Capital preservation is a top priority while providing income, if needed. This is done through the purchase of AAA and AA corporate and/or municipal bonds, depending upon the client's tax bracket. Most of the municipal bonds purchased have escrowed to maturity or pre-refunded provisions, which means they are fully backed by the U S Government. We utilize a "laddered" approach, which is the concept of purchasing individual bonds having maturities that are extended throughout a period of years. The advantages of this approach are that interest rate and principal risks are greatly reduced (see end of page for examples).
Currently about one-half of our assets under management consist of individually managed (as opposed to pooled) bond accounts. These accounts include individuals, retirement plans, and IRA's. Our concern about the highly-leveraged economy, and our commitment to preserving principal, demand that we limit our fixed income holdings to very high quality instruments including U.S. Treasury bonds, AAA and AA corporate bonds, or AAA and AA municipal bonds. Yet in spite of maintaining the highest quality bond portfolios, we have generated very competitive results. Additionally, risk is held to a minimum with a well-diversified bond portfolio. Each individual bond holding only represents 5 to 10% of the total laddered bond portfolio.No subprime or CDO securities are held.
Our approach should meet your income and capital preservation needs. Together, we will discuss all of the alternatives, and develop a bond portfolio (for example, whether taxable or tax exempt) to meet your specific individual requirements. Many investors are concerned about the overvaluation of the stock market, and/or require a particular level of income. However, they also insist that their principal remain intact (Beacon and Heartland Bond Fund investors take note). The best investment alternative for investors with these objectives is our laddered bond management approach. We adamantly oppose the use of bond mutual funds. The recent examples of the halving in price of some Beacon and Heartland Bond Funds reflects the hidden risks of lower quality bonds often found in these portfolios, as well as the more recent practice of including complex derivative transactions such as credit default swaps, collateralized debt obligations and inverse floaters. The following few paragraphs compare the difference between our approach (laddered bond portfolios) and bond funds (see bottom of page for examples): Why a laddered bond structure is superior to a bond fund! Principal at risk: Since a bond fund is a vehicle that holds numerous individual bonds, it has no specific maturity. A bond fund is purchased at a particular price (called net asset value, or NAV), and this price will fluctuate according to the movement of interest rates. Investors cannot hold a bond fund to maturity because there is no maturity. Therefore, there is no guarantee of the return of the original investment (principal) in a bond fund. In a laddered bond portfolio, however, because each bond has a specific maturity date, at which time the principal will be returned (assuming high-grade issues), there is little chance of loss. This represents a major difference! Income at risk: Short and intermediate term bond funds generate income that can vary widely over time as interest rates fluctuate. This is because proceeds from maturities must be reinvested at the current prevailing rates, which may be either lower or higher. On the other hand, laddered bond portfolios (examples appear at the end of this page) that hold a broad range of bonds with various maturities averaging about 11 years, will maintain reasonably stable income returns. Therefore, short to intermediate term bond funds hold somewhat greater risk of income volatility, while there is only minor income risk in laddered bond portfolios. This is also a major difference! Quality at risk: With the exception of government bond funds, a bond fund may hold numerous bonds of lower quality ratings. The Heartland High-Yield Bond Fund's recent collapse in price (-70%) because of the incorrect pricing of some low quality bonds is a recent example. Also, bond managers are now including complex derviative transactions to either increase returns or decrease risk. These highly volatile securities have never been tested under adverse market conditions, and represent another potential unknown hazard. Our laddered bond portfolio will maintain defined high quality standards (AAA). These distinctions are significant for a bondholder: Principal: 2. If rates trend lower, laddered bond portfolios and long-term bond funds will experience higher prices. However, short and intermediate bond funds will reflect only relatively slight price increases. Income: 2. If rates trend lower, short and intermediate bond funds will experience lower income. Long-term funds and laddered portfolios will experience only modest income changes because fewer bonds mature each year. Summary 1. If interest rates trend lower, income from short and intermediate bond funds will decline. A laddered bond portfolio will experience only minimal income reduction. 2. If interest rates trend higher, long-term bond funds will lose principal value, perhaps permanently. A laddered portfolio should not experience total return losses if all bonds are held to maturity. 3. Most bond fund managers face significant competition from their peers, and are, therefore, strongly inclined to maximize their fund's yield by buying lower quality issues. The sensible approach for a person that is interested in principal that is guaranteed
and a reasonably stable income is to acquire individual bonds in a laddered bond portfolio
with specific maturites. This should minimize the possibility of significant loss of principal, provide minimal income risk, very little default risk, and, if interest rates increase, a modest increase in income.
Lang Asset Management *However, when long-term bond funds were purchased between 1946 and 1975 (a 30 year time span), up to 55% unit value losses (from 12.4 to 5.55) were sustained because of rising interest rates. Investors sued numerous bond funds as a result. Source: Standard & Poor's Corporate Bond Yield Indexes Pennzoil (Royal Dutch) due 2009 U. S. Treasury Bond due 2010 CD due 2011 Atlantic Richfield (BP) due 2012 US Treasury Note due 2013 U.S. Treasury Bond due 2016 United Parcel Service due 2020 Mobil Co. due 2021 Johnson & Johnson due 2023
Atlanta Water & Sewer (Pre-Refunded)* due 2008 Atlanta Water & Sewer (Pre-Refunded)* due 2009 Fayette County, Ga. (Pre-Refunded)* due 2010 Atlanta Rapid Transit (Pre-Refunded)* due 2011 Puerto Rico (Pre-Refunded)* due 2012 Fulton County Parks & Recreation, Ga. (Pre-Refunded)* due 2014 *(Escrowed and Pre-Refunded means that U.S Treasury bills are held in escrow to redeem the
particular issue at maturity or first call date; therefore they are rated AAA) **These are not specific recommendations, but represent a hypothetical example of a laddered portfolio. |
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