Contemplating Bond Swaps
Rob Tayloe discusses fixed income market conditions and offers insight for bond investors.
In our experience, we typically work with financial advisors and investors who are seeking to maximize return and/or minimize risk in their portfolios based on their individual goals and needs. When deciding to do a bond swap for an investor, there are several factors to consider. Have the client’s objectives changed regarding maturity or cash flow? Can the portfolio use the loss? Has the investor’s tax liability changed? It is not as simple as looking at the purchase yield to swap into a higher yield.
Prior to the 4th quarter of 2022, the 10-year Treasury had not reached a 4% yield since the 2nd quarter of 2010. Theoretically, any long-term bond is trading at a higher yield than where it was purchased assuming it was bought in the past 12 years. This is more pronounced by the inverted slope of the Treasury curve.
When buying fixed income, it is typically more beneficial to “buy and hold”. There is always a cost in doing a trade as bonds trade on a bid/ask spread. Constantly buying and selling would leave us stuck paying the bid/ask spread every time we swap in and out of positions. When buying a bond, it is important to weigh the variables to make sure specific investments fit a certain portfolio. For buy and hold portfolios, a client should be prepared to hold a bond until it is called or matures.
There are situations where it is appropriate to adjust the bond holdings in a portfolio. An expense could arise that was not previously in the budget such as tuition payments. An account could be looking to offset a gain, so a tax loss swap could make sense. When executing a tax loss swap, we would prefer to adjust to market conditions as well as taking the loss. For example, it may make sense to take on more duration with rates elevated. You could also look to add cash flow if needed or invest certain amounts that mature on or near a specific date to meet upcoming expenses. These expenses could be the purchase of real estate or tuition payments.
If a client invested in a 10-year bond 5 years ago at a 1% yield, it is not as simple as selling that and buying a 4% yield today to “lock in” the 300 basis points in excess yield. You need to look at the take-out yield of the existing position. Weighing the take-out yield versus the yield of the new acquisition is the measurement that identifies pros and cons of a swap. If the bonds sold average a 5% yield and the bonds bought average 4.5%, the swap is giving up 50 basis points of income. You also should consider if the investor has moved to or from a state with a different income tax or if their federal tax rate has changed. Either of these could change which bonds would benefit them the most.
The team of Raymond James’ fixed income professionals can work with your financial advisor to identify the best opportunities available to help you achieve your investment needs and objectives.
The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.
Investment products are: not deposits, not FDIC/NCUA insured, not insured by any government agency, not bank guaranteed, subject to risk and may lose value.
To learn more about the risks and rewards of investing in fixed income, access the Financial Industry Regulatory Authority’s website at finra.org/investors/learn-to-invest/types-investments/bonds and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) at emma.msrb.org.