Is Your Portfolio a SWAN?

SLEEP WELL AT NIGHT (SWAN) – DEFINED
How about an investment strategy that, over the long-term, performs better than stocks, yet provides a greater than 99% chance of preserving your original investment.   Would this sound like an investment strategy that will let you sleep well ALL night?   A properly managed long-term buy and hold municipal bond portfolio can be the answer! 

Recently, Thornburg Asset Management conducted a real rate of return analysis on a series of different assets classes over various time frames.  The results, once adjusted for a properly managed buy and hold municipal bond portfolio strategy, are quite surprising. 

Below are the results of the analysis before the adjustments are made.

 
1Real rates of return (end date of 12/31/10) are calculated by taking nominal returns and adjusting for the following: an assumed 50bp expense cost, inflation over the designated time period, and taxes.

MAINLINE ADVANTAGE: IMPLEMENTING “BUY AND HOLD” WITH HIGH QUALITY BONDS
MainLine advocates a long-term buy and hold strategy that utilizes good credit quality essential service bonds purchased when yields are 5% or greater, while taking advantage of state income tax exempt issuers and minimizing expenses.  To meet MainLine’s investment criteria, we feel the above analysis needs the following adjustments:

  • The Barclays Municipal Bond Index used for the return calculation above assumes the index is purchased at the beginning time period (01/01/81 for 30 year returns) and then sold at the going price on 12/31/11.  We advocate a strategy where bonds are held in the portfolio until they are called -or- mature at par. Ultimately, the investors receive their 5% book yield with no change in principal value.
  • State income taxes were not adjusted for in the Thornburg return analysis. Our returns assume a  5% state income tax rate, with half of the bonds in the portfolio exempt from this tax. For the 30-year time frame, the average federal tax rate was 39.3%, which is then reduced even more by the implied 2.5% (50% of 5%) state exempt status of the portfolio.
  • MainLine’s one-time commission charge is taken off the yield at the time of purchase, leaving the bond with a net yield of 5%.

Below are the adjusted results for a 30 and 20-year investment horizon.


1Real rates of return (end date of 12/31/10) are calculated by taking nominal returns and adjusting for the following: an assumed 50bp expense cost, inflation over the designated time period, and taxes.

 We have limited the comparison to 30 and 20 year time frames, based on the assumption we have laddered bonds maturing from 20 to 30 years.  Since most municipal bonds have been called or refunded over the last 20 years, we realistically assume investors have received par back for their bonds and have repurchased suitable replacements.  We consider results to be very conservative; if bonds were actually bought 30 years ago, a tax-exempt yield exceeding 10% would have been booked.  This is double the 5% book yield assumed in the analysis.


Source: Bloomberg.  *Bond Buyer Index is made up up 25 bonds with 30 year maturities a credit ratings of A1 by Moody’s.  Index is priced weekly on Thursdays using the yield-to-matuirty. Points in chart are for last Thursday of the month.  Data points in chart are for last Thursday of each month.  Data from 01/01/80 to 09/30/11.

Historically, long-term yields of 5% are prevalent in the municipal market and are an important psychological level for investors.  Even during this recent low rate environment, over the last 30 years, the 5% strategy has been very manageable assuming the following criteria are met and adhered to:

  • Patience
  • Proper diversification techniques;
  • The ability to access numerous underwriting firms; and
  • A credit research staff that affords comfort in purchasing “A” rated issuers.

 SUMMARY
As the results above demonstrate, we feel that a MainLine managed municipal bond strategy would have outperformed stocks over the last 20-30 years.  In addition to this outperformance, high quality municipal bonds have historically provided a greater than 99% chance of maintaining your investment.  In fact, a recent Moody’s analysis shows that over the last 30 years, municipal bonds rated investment grade or higher have defaulted at an extremely low rate of .06%.

 Now, time to rest those eyes and let your money keep working for you.  You have nothing to worry about.  Sleep tight!

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Posted in General, Investment Strategy

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