Increasing Credit Exposure
As part of our month end rebalancing process of the Core Portfolios, we have increased credit exposure and lowered our exposure to government bonds and cash. Our detailed reasoning follows the table below. Core Portfolio diagnostics, updated for this recent rebalance and credit adjustment, are below for each Core Portfolio. This recent shift increases our expected return while decreasing our volatility. Both duration (which lowers risk) and yield increased because credit spread as a percentage of total yield is very large in this low rate environment. Total yield levels on these portfolios are starting to sneak up a bit with the spread widening, it's nice to see.
We are increasing our allocation to High Yield Bonds and Investment Grade Bonds. We are decreasing our exposure to Government Bonds and Cash. Corporate bond spreads have widened considerably over the last 6 months. Investment Grade bonds have moved from 1% above comparable treasuries to 2% above.
High yield bonds moved from paying 3% above the risk free rate to paying 5.5% above the risk free rate. Spreads are currently at 4.5% above comparable risk free treasuries.
Investors are being paid considerably more to take on the credit risk of these bonds. We believe the extra risk is worth the reward. The reason spreads widen is due to fears that a slowing economy will make it more difficult for corporations to fulfill their debt obligations. Our research has shown that the wider the credit spread, the more likely an investor is to earn a premium return over treasuries. The noticeable exception is when the economy goes into a recession. We are confident that the economy will not be in a recession during 2019. While corporate debt levels are high, the servicing of these debt levels remains low due to the low interest rate environment. With a clear shift in Fed Policy and minimal inflation, we see little risk of materially higher rates in the near future. This means investors should be able to earn a considerable premium by reallocating from treasuries and cash (risk is 100% duration) to investment grade (risk is 50% duration and 50% credit) and High Yield (risk is 15% duration and 85% credit). Please let us know if you have any questions or would like to discuss this reallocation in greater detail. Also, we will be sending an electronic version of our updated 2019 Investor Packet to our Core Portfolio clients in the next few days. If you would like a hard copy please contact us and we will send that also. One last operational note. Some of our Gmail users have told us our emails end up in their promotional folder instead of their inbox. If you are having this issue, simply drag one of our emails from the promotional folder to your inbox, and then future emails should go directly to your inbox. Thanks The GreenPort Team