Skittish investors concerned about debt woes in Europe and the United States have plowed into government securities in recent months, seemingly undeterred by their rock-bottom rates of return. But tepid demand for two-year Treasury notes in recent auctions has underscored signs that investors might be growing weary of the historically low yields on safe-haven securities.
"Looking at core, traditional protective fixed income—U.S. treasuries, cash—it's hard to look at those now and say that's a good deal," says Jason Pride, director of investment strategy at Glenmede, a wealth and investment management firm based in Philadelphia.
Yields rose slightly on Wednesday—10-year T-bills yielded 3.14 percent, while five-year notes inched up to 1.7 percent—but they still hover near historic lows, prompting many investors to seek other means of portfolio protection that don't sacrifice returns.
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It might sound counterintuitive, but taking on a bit more risk can make a portfolio safer because it allows investors to capitalize on the benefits of diversification and capture more yield, Pride says. That extra yield can provide more cushion to help a portfolio withstand market swings.
To be sure, there will be fluctuations in the market, but those ups and downs might not warrant the "extreme" forms of protection—historically super-safe U.S. Treasuries and cash—investors are now flocking to. Instead, Pride and others suggest a more middle-of-the-road approach, which includes investing in asset classes that might skirt the riskier side of the fixed-income domain, but offer the boons of diversification and yield.
Here's a look at a few asset classes that still provide ballast for portfolios, but allow investors to reap better yields:
Corporate bonds. While payouts have decreased significantly over the past few years, investors can still find value in corporate bonds. Experts suggest sticking to shorter durations of between two and eight years to help mitigate interest-rate risk.
"The credit markets make up a large portion of the fixed-income world, so you should have diversified corporate bonds, not just Treasuries," says John Thompson, co-head of investment advisory services at Ibbotson Associates, a Morningstar subsidiary. "Both investment-grade [bonds] and maybe a sliver of high-yield or distressed debt because [those do] have higher yields."
Emerging market debt. Developed countries such as the United States and the U.K. continue to grapple with high public debt and chronic deficits, but many developing countries have strong balance sheets and responsible budget practices. Rob Lutts, president and chief investment officer of Cabot Money Management, recommends a few ETFs for emerging-market debt exposure, including iShares JPMorgan USD Emerging Markets Bond (symbol EMB) and WisdomTree Emerging Markets Debt (ELD).
The rationale is simple: Emerging markets bonds offer generous yields, and the prospects for growth in the underlying economies are stronger than those of developed nations. "They have been performing very well year-to-date, and if you believe the current trend in strengths of governments [will] continue, the wealth and power moves to the stronger governments," Lutts says.
Also, other countries have different interest-rate cycles, which can help mitigate volatility. "When the U.S. is doing poorly, Australia may be doing much better," Thompson says. "You have to think about these kinds of trade-offs in your portfolio—there could be a few downturns with some of the asset classes, but you have to take into account the diversification benefits you get from going into diverse countries."
The currency exposure built into the WisdomTree Emerging Markets Debt fund can also help investors ride out a declining dollar, as central banks in developing countries raise their interest rates, boosting their currencies. For example, the Brazilian real is up almost 6 percent against the dollar this year, while the Russian ruble appreciated almost 9 percent compared with the dollar. For U.S. investors, foreign currency appreciation increases the value of assets once they are repatriated in the United States.