The Safer Side

The collapse of equity markets over the past 12 months scared a lot of investors out of stocks and into anything safe: money market funds, certificates of deposit, and government bonds. In fact, money flowing into corporate and government bond exchange-traded funds increased by more than 30 percent in the first quarter of 2009.

This risk aversion also can be seen in the recent yields of the 10-year Treasury note. Investor demand for 10-year Treasuries drove yields down to almost 2 percent. While 2 percent yields surely beat losing money, playing it too safe might be the riskiest strategy of all.

The worst fixed-income investment over the next few years could be government Treasuries. The government is running up a huge deficit in an attempt to stimulate job creation, consumer spending, and lending. We hope it works, but it could result in an inflation spike and higher interest rates down the road, a potentially devastating problem.

With government bonds, your principal is safe, but investors in Treasuries are nonetheless exposed to interest rate risk. As interest rates begin to rise, the market value of lower interest rate notes and bonds will plummet because bond prices move in the opposite direction of interest rates. This can be a real problem if your cash needs change while holding the bond. Even if investors hold those bonds to maturity, higher inflation could erode the buying power of bonds yielding only 2 to 3 percent.

One alternative to consider: investment-grade corporate bonds. Though corporate bonds have staged a late-spring rally, interest rate spreads between corporate bonds and Treasuries remain wide because of investor concern about the risk of default on corporate bonds.

The market thaw this spring helped renew investor demand for corporate debt, and in the first part of 2009, investors were more willing to buy riskier assets. In mid-April, Goldman Sachs Group, Inc. (NYSE: GS), Northern Trust Corporation (Nasdaq: NTRS), BB&T Corporation (NYSE: BBT), and Credit Suisse Group AG (NYSE: CS) offered a total of $5.6 billion in corporate debt, the largest weekly new issuance since August of 2008. Investment-grade corporate bonds were yielding, on average, 7 percent, a very nice yield depending on a company’s risk profile.

Investors can find many Minnesota-based companies with debt issues in the market. The Travelers Companies (NYSE: TRV), Target Corporation (NYSE: TGT), and Best Buy Company (NYSE: BBY) have bonds of varying maturity schedules with yield-to-maturity between 6.75 and 7.5 percent. On the higher-yield end of the spectrum, Supervalu (NYSE: SVU), the second-largest supermarket retailer in the United States, recently issued $1 billion of debt with a coupon interest rate of 8 percent. The bonds are due in 2016.