m;The share price of the stock could increase, but not above
$22.50, in which case the options will expire worthless
and the client keeps the $1,800, providing a 4. 1 percent
additional return on the stock, based on the present price.
m;The share price of the stock could increase above $22.50, in
which case the client will have to sell the stock for $22.50.
However, the client will still keep the $1, 800.In addition,
the stock will have appreciated 23. 2 percent, providing a
$12,430 total return (+ 27. 3 percent) on the stock, based
on the present price.
In February 2011, Bank
of America Merrill Lynch
conducted a poll of 188
global fund managers and
found that 66 percent of
the fund managers are
underweight in bonds and
that this figure is up from
54 percent in January.
Note that if the stock
market moves significantly
higher from present levels
during the next five months
(like 15 percent or so), then
the option strategy may not
enhance the performance
of your client’s portfolio.
If only modest appreciation occurs or if a market
correction develops, then
this strategy should be
beneficial.
Corporate Bonds
Some clients have benefited from holdings in
corporate bonds or their
corresponding bond funds, and the investment returns on
corporate bonds in 2009 and 2010 were excellent. Some
lower-grade bonds, for example, returned well over 25 percent during that two-year period. As we learned from the
Great Recession, corporate bonds are considered riskier than
government bonds, but there certainly is a place for them in
some clients’ portfolios. Since the upswing in the economy
and the markets, the spread between government bond yields
and corporate bond yields has narrowed once again and most
money managers surveyed are reducing their bond allocations
in anticipation of rising interest rates.
In February 2011, Bank of America Merrill Lynch conducted a poll of 188 global fund managers and found that 66
percent of the fund managers are underweight in bonds and
that this figure is up from 54 percent in January. Moreover,
a Fitch survey of European managers found that 68 percent
expect lower inflows of funds into bonds this year. 5
Again, corporate bond mutual funds may be less desirable
than individual issues. Investing in high-quality individual issues
of corporate bonds can be another way to maintain the level of
income that clients have become accustomed to in recent years.
Certainly I have not been able to cover all the alternatives for
fixed-income investing in the breadth of this article.
Investment managers feel that interest rates are going to
rise, but none of us knows exactly when that will happen.
We also cannot yet determine what the after effects will be
when the Federal Reserve Board concludes its second round
of quantitative easing. Therefore, it is clear that we have to
use and will need to continue to use innovative approaches
to establishing fixed-income alternatives for our clients. This
means we have to do things differently than we have in the
past as well as implement a wider variety of approaches.
With many of these approaches there is more risk, and
perhaps that is our most daunting task: explaining risk in
meaningful, tangible terms so that clients can decide which
trade-offs are acceptable to them.
Some of our clients should not take on more risk or will
not choose to take it on; we need to explain to this group
that they may have to settle for lower interest rates and less
income from their portfolios for the next while. This is not an
easy topic, but sometimes it is reality unless the client allows
managers to utilize more varied approaches than in past years.
Managing fixed-income portfolios at or near the bottom
of an interest rate cycle is a great challenge and I know many
of us have been there before in our careers; I think it is fair
to say, however, that none of us have had to manage assets
at the bottom of such a deep interest rate cycle for such a
sustained period of time. I wish everyone the best of luck as
we rise from a historic interest rate trough. n
Endnotes
1Waggoner, John, “Don’t laugh, money funds may beat bonds,” The
Burlington Free Press, November 8, 2010.
2Endnote 1.
3Sender, Henny, “Get ready for a $1.20 euro, warns Fink,” Financial
Times, November 27-28, 2010.
4Authers, John, “Where dividends fit in the financial puzzle,” Financial
Times, March 5-6, 2011.
5Newlands, Chris, “Bonds look vulnerable as interest rates set to rise,”
Financial Times, March 7, 2011.
ABOUT THE AUTHOR
THOMAS W. BRIGHT, CTFA, is a vice president and trust
officer with Community Financial Services Group based
in Newport, Vt. In addition to his CTFA designation with
the Institute of Certified Bankers, he holds an M.B.A. in
international business from the Thunderbird School of
Global Management. He also serves on the ABA Trust &
Investments editorial advisory board. Reach him by e-mail
at tbright@cfsgtrust.com.
