Diversify Your Income Sectors

Jeffrey Ptak wrote favorably about bonds at current levels, noting that yields are at decent levels and that the risk versus reward is pretty close to being balanced, which was not the case when yields were at 2% or less. He references iShares 7-10 Year Treasury ETF (IEF) a couple of times, so presumably he was talking about duration. 

Here's a concise version of the bond math he was talking about courtesy of Gemini. I assumed ten-year Treasuries now at 5% and what the price decline would be if the prevailing yield went to 6%.

The chances of 4% aren't impossible if something bad happens, but I don't think 3% could happen anytime soon. I doubt we'll see 7% anytime soon either, but that seems more plausible than 3%.

For a while, I have been framing this as being about adequate compensation. Is 5% adequate compensation for the risk and volatility of going out ten years? That's up to each of us to figure out for ourselves. My answer is an easy no. There are many ways to get similar or better yields with nowhere near the interest rate risk or volatility. 

The ETFs above track 3-year, 10-year, and 20-year Treasuries, respectively. I included their yields in the green box, and you can see the volatility numbers off to the right. Again, this is for each of us to decide: is the extra yield worth the extra volatility?

Collateralized loan obligation ETFs have become a huge income market niche. I've been using JAAA for a while, but here are a couple of I've never heard of that look pretty similar.

They both yield around 6% and, sticking with phrasing from previous blog posts, I think that is what people want their bonds to look like. 

At about a 5% yield, it's safer to add some exposure to duration but not 40%. I wouldn't put 40% in CLOs either. I wouldn't put 40% in any income sector. We talk a lot about owning different income sectors to help mitigate the risk. Anyone comfortable with the risk and volatility of ten-year Treasuries doesn't have to load up on them. 

Diversify your diversifiers? Diversify your income sectors.