PLANADVISER - November/December 2017 - 61

Often, in a low-interest-rate environment, investors are
compelled to find higher yields, so they choose high-yield
corporate bonds, he says. " When they do that, they have
taken on a greater risk of default, and they find themselves
in investments that act like securities do. "
According to Gilliam, investors are tempted to go to
managers that have outperformed, but risk can be masked
in a low-interest-rate environment. If the markets turn,
investors will fail to get the same outperformance. There
needs to be full transparency of the sources of outperformance,
he advises.
Evaluating Fixed-Income Vehicles
Sommariva notes that evaluating fixed-income vehicles is
complex. He suggests, when a plan sponsor client wants to
invest in a particular sector, the adviser look into that sector
and find companies that are not highly leveraged, checking
to see if they have a track record of paying back principal
and interest.
Fort Pitt constantly monitors investors' portfolios to
see if a specific company in a sector within a portfolio
makes an adverse move. Advisers can make the decision
to remove that company, or to keep it if the company is
expected to pay. " A constant monitoring of portfolios is
required, " Sommariva says.
Gilliam says, when evaluating fixed-income options,
advisers must first understand the plan sponsor client
and its risk tolerance. For DB plans, advisers need to know
the time horizon and goals for fixed-income investments.
When evaluating specific fixed-income managers, he says,
look beyond relative performance and get an idea of the
type of risk the manager is taking. He suggests advisers
be wary of active managers overweighting vehicles that
do best in volatile markets-e.g., indexed and credit vehicles-because
when the market changes, performance will
be subpar. Gilliam also recommends using managers that
are not necessarily at the top of the leader board. However,
he says, do not switch out managers whose investments
may have high volatility in performance once they perform
better. Look at the underlying construction of investments
to determine if they are worth the risk.
Managers generating the highest yield may well be the
ones taking on higher risk, and those performing well now
may become underperformers next year, Wander says.
When you assess fixed-income holdings in target-date
funds (TDFs) for a DC plan, Gilliam says, the funds should
start out with 5% in fixed income for participants in their
early 20s, and, over time, as the participants approach
retirement, the TDF should have a 60% allocation to broadly
diversified fixed income. Then, in the five years preceding
participants' retirement, or once they have entered it, TDFs
should switch from higher-risk fixed-income vehicles to
cash and inflation-protected securities. " For a person in
retirement, 75% in fixed income is a safe haven, " Gilliam
says. " Plan sponsors don't want participants to be worried
their life savings is at risk, especially in retirement when
they don't have time to withstand market storms. "
The Vehicles That Are Best for Now
In its PGIM Fixed Income 4th Quarter Outlook, PGIM Inc.
points to three asset classes it currently finds attractive:
structured products, U.S. and European bonds, and
emerging markets.
" High-quality structured products generally earned their
carry in Q3, " the report says. " For example, the spreads on
AAA tranches of CMBS [commercial mortgage-backed securities]
and CLOs [collateralized loan obligations] finished
the quarter basically unchanged. Range-bound spreads
were consistent with our expectations, and this remains our
base case in Q4. Our favorite picks continue to be AAA CLO
and CMBS bonds. "
As for U.S. and European bonds, the outlook states, " [In]
both the U.S. and Europe, we believe that spreads are at fair
levels but have the potential to grind tighter in Q4 given
the favorable fundamentals, ongoing investor demand for
yield and minimal risk of a recession in the near term. "
The report goes on to say, the emerging market debt
sector continued its solid performance in Q3, with all
segments posting healthy returns. In the hard currency
sovereign space, the higher-yielding issuers reported the
highest returns, particularly El Salvador (9.7%), Belize
(7.9%) and Suriname (7.06%).
In addition, a number of
countries returned more than 5%, including Argentina,
Egypt, Ethiopia, Ghana, Iraq and Mozambique.
Wander suggests that instead of thinking about what
sectors are attractive, advisers should think long-term and
not overreact to current dynamics.
Specific to DC plans, Gilliam says, fixed-income investment
menu options should include low-volatility and
stable components. " Advisers should focus on making sure
plan sponsors are not including high-risk options but very
conservative and broader fixed-income options, " he says.
" We feel the single biggest mistake bond investors can
make is to overreach for yield. The wisest thing is to focus
on the long term and not make changes based on shortterm
variations in the market, " Wander concludes.
-Rebecca Moore
KEY TAKEAWAYS
* A case can be made for including fixed income in
a portfolio because interest rates are expected to
remain low in the near future and bond returns are
expected to remain stable.
* Bonds are viewed as a good hedge against equities,
should the bull market come to a close.
* In the event that interest rates rise, bond ladders enable
DB plan investors to take advantage of rising rates.
* Experts recommend advisers seek out bonds in
industries that are not highly leveraged and that have
a proven track record of paying back principal and
interest.
planadviser.com november-december 2017 | 61
http://www.planadviser.com
PLANADVISER - November/December 2017

Table of Contents for the Digital Edition of PLANADVISER - November/December 2017
