Dear Investors and Friends,
In December, we began a three-part series on the fundamentals of fixed-income investing with a focus on Why Bonds—highlighting how bonds can balance risk and reward in a portfolio. This month, we turn to What Bonds to Buy, focusing specifically on asset allocation within fixed income and cash management. Next month, we’ll discuss security selection.
Options within Fixed Income & Cash Management
When considering what bonds to buy, it’s essential to understand the types of bonds available and how they fit into your investment objectives. There are seven primary options available to investors, each with unique characteristics and purposes
Let’s start with U.S. Treasuries, often regarded as the safest investment in the world. Issued by the U.S. government, Treasuries come in various maturities—from short-term T-bills to medium-term T-notes and long-term T-bonds. Their unparalleled liquidity and explicit government guarantee make them the benchmark for risk-free returns.
Next, we have mortgage-backed securities (MBS), which are bonds backed by pools of mortgages and issued by entities like Fannie Mae, Freddie Mac, or Ginnie Mae. While MBS offer slightly higher yields than Treasuries, they also carry prepayment risk, as homeowners may refinance and pay off mortgages early.
Agency bonds, issued by government-sponsored enterprises such as the Federal Home Loan Banks or the Tennessee Valley Authority, provide another low-risk option. Although not explicitly guaranteed by the U.S. government, their implicit backing ensures a high degree of safety, with yields slightly above Treasuries.
In the corporate bond market, investors can choose between investment-grade and high-yield bonds. Investment-grade bonds are issued by companies with strong credit ratings, providing higher yields than Treasuries in exchange for moderate credit risk. High-yield bonds are issued by companies with lower credit ratings and offer significantly higher yields to compensate for the elevated risk of default.
Turning to municipal bonds, there are two key types: taxable and tax-exempt. Taxable municipal bonds, often issued for infrastructure or economic development projects, provide higher yields than Treasuries but carry slightly more credit risk and reduced liquidity. Tax-exempt municipal bonds, on the other hand, offer federal (and sometimes state and local) tax-free interest, making them especially appealing to high-tax-bracket investors.
Comparing Yields Across Bond Markets
The chart below illustrates the yield curves for these bond categories, ranked from the lowest to the highest yields:
A few important observations:
Common Investor Pitfalls
Many investors hold bonds or bond funds without fully understanding their purpose, often leading to disappointing outcomes such as underperformance, liquidity constraints, or unrealized potential. A common issue we observe is the over-concentration of portfolios in the bottom three lines of the yield curve, where yields are the lowest. This misallocation frequently results in significant missed opportunities.
Two recent examples from new RCM clients highlight the consequences of poor fixed-income strategy. In one case, a client invested heavily in long-term Treasuries in 2020 due to their perceived safety, only to face a 35% mark-to-market loss when interest rates rose. Another client encountered severe liquidity issues after funds were placed in a restrictive investment vehicle that limited redemptions, preventing access to their capital when urgently needed. These examples underscore the importance of aligning fixed-income investments with clear objectives and maintaining flexibility.
RCM’s Approach to Asset Allocation
At RCM, we align each client’s investment objectives with the characteristics of the bonds we purchase, ensuring every decision is tailored to individual goals. Our process begins by segmenting a client’s financial needs into distinct buckets. Examples follow:
This targeted approach contrasts sharply with generic “core bond strategies” that often over-allocate to low-yielding Treasuries, MBS and Agencies. Instead, we prioritize sectors and structures that optimize performance while addressing each client’s unique financial needs.
In February, we’ll dive deeper into security selection within the bond space, ensuring you have a comprehensive understanding of what bonds to buy and why.
Thank you for trusting us with your capital.
Warm regards,
David and Mike
Disclaimer
Roosevelt Capital Management LLC is a registered investment adviser. The information presented is for educational purposes only and is not intended to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein.
Past performance is not indicative of future performance. Principal value and investment return will fluctuate. No guarantees or assurances that the target returns will be achieved, or objectives will be met are implied. Future returns may differ significantly from past returns due to many different factors. Investments involve risk and the possibility of loss of principal.
While all the values used in this report were obtained from sources believed to be reliable, all calculations that underly numbers shown in this report believed to be accurate, and all assumptions made in this report believed to be reasonable, Roosevelt Capital Management LLC neither represents nor warrants the values, calculations or assumptions and encourages each prospective investor to conduct their own review of the audits, values, calculations and assumptions.