At William Blair, our wealth advisors take a holistic approach to building clients’ portfolios, from understanding their time horizon and risk tolerance to their investment strategy objectives and goals. This hands-on, personalized capability forms the foundation of a well-diversified portfolio designed to withstand various market conditions long term.
Fixed income is a key component of any asset allocation decision. In constructing fixed-income portfolios for our clients, our wealth advisors and fixed income team carefully analyze risk and opportunities across countries, sectors, and issuers, as well as review positions to assist in creating strategies that are tailored to each client’s situation.
By adding fixed income to a portfolio, investors can spread credit and interest rate risk across various assets, helping to reduce overall sensitivity to market swings. William Blair’s Debra Schalk, fixed income trading and strategy director, highlights the ways these investments may benefit your investing strategies.
Designing Portfolios With Purpose
Laddering is an investment strategy where you purchase securities with staggered maturity dates. Doing so helps mitigate reinvestment risk and limit the guesswork related to future interest rates with smoothed income streams, reinvesting as bonds reach maturity to fill potential gaps in the laddered portfolio. Ladders can be created immediately, over a specific period, or to correspond with investors’ needs if they have specific goals, such as tax payments.
Diversified municipal bond portfolios aim to reduce risk by limiting the investment allocation to securities issued from any one state, typically to a maximum of 10%. But in state-specific portfolios—which can often provide tax benefits—it's common to concentrate investments in one state while still diversifying across multiple local issuers. States such as California, New Jersey, New York, or Pennsylvania enjoy both state and federal exemptions, increasing tax yields considerably.
Portfolios can be constructed to lock into higher cash flows and employ call features in a laddering strategy for clients with longer-term goals. A call feature on a bond gives issuers the right to redeem the bond before its maturity date, and a portfolio may have bonds with a 5% or higher coupons with call features every year, diversified by state. Premium bonds may vary less in price during fluctuating interest rate environments. As bonds are called away, our fixed income team reevaluates the ladder to fill in potential gaps in the cash flows by the call date. These types of premiums, or “kicker bonds,” have higher attractive yields than other non-call bonds.
Offsetting Potential Risks
With a fixed cash flow and maturity date, bonds can help offset volatility from other asset classes and provide capital preservation. Bond prices fluctuate in value as interest rates and market conditions change, but if an investor holds to maturity and the issuer fulfills the expected obligation, all principal is returned. It’s important to remember that when interest rates rise, bond prices fall, but this is a key part of bond risk. Inflation often reduces the value of fixed-interest payments, which can impact purchasing power over time. To manage these risks, investors often diversify across bond maturities and include inflation-protected securities or TIPS (Treasury Inflation-Protected Securities), which are issued by the U.S. Treasury and are designed to protect investors from the adverse effects of inflation.
Credit risk relates to a bond issuer’s inability to meet obligations, and increasing credit risk can be reflected in a downgrade in bond ratings in the portfolio. William Blair’s fixed income team carefully evaluates rating actions and trading activity to determine if they fit our clients’ goals.
Fixed-Income Strategies
Fixed-income investments are just one part of an overall financial plan. Our experienced and dedicated fixed-income specialists work with your William Blair wealth advisor to develop an investment strategy that suits your specific needs. Contact your wealth advisor to learn more about these capabilities.
Disclaimer
Risk Factors: As with any type of investment, there is a trade-off between the risk you are willing to assume and the potential return you could receive. Generally, the higher the potential reward or return, the greater the risk inherent in an individual fixed-income security. There are several key variables that comprise the risk profile of a bond. Certain risks may be applicable to a fixed-income security, including but not necessarily limited to the following:
Interest Rate Risk: It is critical to understand that rising rates mean declining bond prices. If you intend to hold until maturity, this may be of less concern. In this period of uncertainty and volatility, it is important to understand this risk. Interest rate movements usually have an impact on bond prices. When interest rates rise, the price of existing bonds typically falls. If you must sell your bond into this type of interest rate environment, you may get less than you paid for it. The volatility created by interest rate risk is greater for longer-term bonds and usually declines as the maturity date gets closer.
Market Discount: When a municipal security is acquired in the secondary market for less than par value, the security may have "market discount." The amount of market discount is equal to the excess, if any, of the stated redemption price at maturity over the basis of the security immediately after its purchase by the investor. Market discount occurs when the value of a municipal security declines after its issue date—which often may occur due to a rise in interest rates. The fact that a municipal security bears market discount may significantly affect its tax treatment. Under federal tax law, for bonds purchased after April 30, 1993, the market discount is taxed at the investor's ordinary income tax rate, rather than the capital gains rate. Please consult your tax advisor for information regarding whether you are subject to state and federal taxes in connection with the purchase and sale of municipal securities.
Default Risk: If a bond issuer fails to make either a coupon or principal payment on its bonds as they come due, it is said to be in default. This could arise in connection with the issuer's bankruptcy or a failure to meet some other provision of the bond indenture, such as a reporting or debt service reserve requirement. Bondholders are creditors of an issuer. There are differences in the order of priority of payment among all the bondholders of an issuer, and the type of bond you hold will determine your status.
Credit Risk: A bond's credit quality is an important consideration when evaluating investment choices. Credit rating agencies may assign a credit rating to a bond and/or issuer based on the issuer's financial condition and management, economic and debt characteristics, and specific revenue sources securing the bond. The highest ratings are AAA (Fitch and S&P) and Aaa (Moody's). Bonds rated in the BBB/Baa category or higher are considered investment grade; bonds with lower ratings are considered higher risk, speculative or high yield. Lower rated bonds will often have higher yields to compensate investors for increased risk. Issuers may pay a premium to an insurer, who provides interest and principal payments in the event the issuer fails to do so. The credit rating of insured bonds can be higher than that of the issuer. In the case of insured municipal bonds, it is important to evaluate and know the rating of the insurer and issuer. The rating of the issuer is sometimes referred to as the underlying rating.
Liquidity Risk: There are many factors that influence your ability to sell your bonds prior to maturity and the price you will receive. The two most significant are changes to the bond issuers' credit ratings and the prevailing interest rates. If the bond’s original issuance was small, that may also affect liquidity. Finally, the bond may have features or attributes that are not attractive to buyers in the current market. Bonds are generally more liquid during the initial period after issuance, as that is when the largest volume of trading in that bond generally occurs. The individual bond type is also a factor in determining how liquid the bond's market is.
Call Provisions: Bonds may have a call feature that allows or requires the issuer to redeem the bonds at a specified price and date before maturity. Since a call provision offers protection to the issuer, callable bonds usually offer a higher yield than comparable non-callable bonds to compensate the investor for the risk that the investor might have to reinvest the proceeds of a called bond at a lower interest rate. Bonds are often called when interest rates have declined from the time the bond was issued. Before you buy a bond, check to see if there is a call feature and, if there is, be sure to consider the yield to call as well as the yield to maturity. Investors considering the purchase of callable bonds should use caution, since a call may result in a lower-than-expected yield or even a loss. Investors may also face reinvestment risk (see below). Investors should also be aware of mandatory extraordinary redemption provisions. These are provisions which give a bond issuer the right to call the bonds due to a one-time occurrence, as specified in the offering statement. The circumstances for these redemption provisions could range from natural disasters, interruption to revenue sources, unexpended bond proceeds, cancelled projects to almost anything else. Investors need to read the offering statement carefully to understand all the circumstances by which a mandatory extraordinary redemption can be triggered and the risks associated with such redemptions.
Put Provisions: A bond may have a put provision, which gives you the option to sell the bond to an issuer at a specified price and date prior to maturity. Typically, investors exercise a put provision when they need money or when interest rates have risen so that they may then reinvest the proceeds at a higher interest rate. Since a put provision offers some protection to the investor, bonds with such features usually offer a lower annual return than comparable bonds without a put. Note that the issuer may limit the number of bonds it will allow to be put back in a given year. As a result, an investor may have to wait until the following year to exercise the put.
Reinvestment Risk: In a declining interest rate environment, bondholders risk having to reinvest their interest income and any return of principal, whether scheduled or unscheduled, at lower prevailing rates.
Legislative Risk: The risk that changes in legislation can have an impact on expected rate of return or credit worthiness of investment decisions and the market. For example, a change in the tax code could affect the value of taxable or tax-exempt interest income.
Concentration Risk: The risk that an investor is undiversified with a concentrated portfolio of bonds issued by a small number of issuers, issues or particular sectors.
EXTREME MARKET CONDITIONS: In the event the bond markets are experiencing extreme market conditions, the fixed income securities market may experience a shortage of liquidity and divergent prices available for your securities. If this occurs, William Blair will revise its fixed income order handling procedures, including but not limited to taking a longer period to search markets and investigate pricing, conducting extended searches of bids and offerings of dealers and electronic trading platforms, and discussing price determinations with trading supervisors.
This information is not intended as a recommendation to purchase or sell any securities. William Blair may effect principal transactions or have positions in the securities mentioned herein and may also have been a manager or a co-manager of a public offering of securities or a financial advisor of the issuer within the last three years. In addition, employees of William Blair may have positions and effect principal transactions in the securities of the issuers mentioned herein. Please consult the security's offering document for more complete information before investing.