August 2011
An Interview with Fixed Income Manager Christopher Keith
An Individual Bond Portfolio Can Offer a Variety of Benefits
While a number of our clients make use of our dedicated bond management service for their fixed-income needs, some of you may be unfamiliar with this program and its experienced leader, Chris Keith. Given the current economic and market environment, this seemed like a good opportunity to check in with Chris. In the following interview, Chris talks about the role of bonds in an overall portfolio, how he works with clients who want to build a custom bond portfolio, and what area of the bond market he likes today.
“You've just celebrated your tenth anniversary at KIM. Tell me a little bit about both your prior experience and life as KIM’s “bond guy.”
I'm proud of claiming that I have always been "the bond guy." I've never traded stocks, commodities, currencies or real estate - only fixed income. And wherever I have worked (past employers include Robertson Stephens, Donaldson, Lufkin & Jenrette and Dean Witter Reynolds), I have provided high-net worth clients with a low volatility, lower risk portfolio by customizing a dedicated individual bond component to their investment line-up. One thing I have found is that many investors have a solid grasp on stocks (they know that buying IBM at $122 and having it appreciate to $182 a year later is a good thing), but when it comes to bonds, just how you benefit and make money seems a little more difficult to fully follow.
Fortunately, at the newly combined firms of Kobren Insight Management and Adviser Investments, I am complemented by an experienced and dedicated group of relationship managers who “get it” when it comes to understanding the benefits of bonds and they help me relay this message to the client base.
My Kobren experiences over the past ten years have been very rewarding. I have enjoyed some great successes and, of course, a few setbacks. This is a very competitive business that we have chosen to work in and it necessitates that we are always on our “A-game.” I’d say the most comfort our bond clients felt was during the worrisome period in 2008 when other markets were falling. That was when investors really began to understand and appreciate the value of diversification.
“What does the typical managed bond client look like?”
For the most part there is no "typical" bond client. I will say that my (our) clients do have one thing in common and that is that they have amassed a substantial amount of wealth. After that, each client's objective differs for the most part. Many learned the hard way (past bear market periods of 2000-2002 and 2008) that they were not properly diversified and had too little exposure to bonds. It's easy to see how many investors had little bond exposure just by looking at the S&P 500's performance during the late 1990s. For the five year period from 1995 to 1999 the index returned more than 20% per year! Against that backdrop, I had a tough time convincing clients they needed a bond portfolio with 10-year Treasuries averaging "just" over 6%. However, after major market disruptions such as the dot.com bubble burst and the sub-prime mortgage market meltdown, investors altered their thinking.
Others come to us because they wish to shelter investment income from taxation. I fully understand the necessity of taxes, but if an investor can keep a little extra savings through tax-exempt or tax advantaged investments, then why not? In sum, there are many reasons investors come to KIM and each is treated as unique when I develop their portfolios.
“What were some of the reasons they decided to work with you?”
I think once they see the tools we have and the resources we commit to a managed bond portfolio, along with the passion we have for the asset class, they recognize that this is going to be a good fit. One of the best things we do is prepare an example portfolio. This example paints a clear picture of what a complete bond portfolio will look like. I firmly believe that the more our clients understand about bonds, the bond market and the way we structure portfolios, the happier they will be with the end result.
“How do you invest your client’s money?”
Cautiously! People on the other side of the trades I make - those that I am buying the bonds from, can sometimes get a little frustrated with my pace. I really do try and make sure that I have reviewed all my options before committing to a specific trade. If there is a better offering out there then I want it. I have to. This is a relatively low interest rate world right now and every basis point counts.
“How did you go about constructing a portfolio for a client?”
The first step involves discussing with the client the types of bonds that are right for their particular situation (tax-exempt, tax-advantaged or fully taxable). Once that is determined, then I wait for the right time to start creating the portfolio. By that I mean that I ideally look for a day when the bond market is trading down on weakness - I tend to be more active in buying bonds on down days than on up days.
In structuring the portfolio, my goal is to generate a relatively even interest payment in every month of the year. That's important because many of our clients depend upon their bond portfolio to augment their income. It's always a little easier at first because everything is wide open, and I can shop for whatever bonds happen to offer the best prices at that time provided they meet our quality criteria. As the investment process continues, it gets a little harder as I have fewer options in filling out the portfolio. For example, if I have income being generated in every month except say May and November, then I’d prefer to focus on finding a bond with those payment dates.
The other element that I build into the structure is frequent "liquidity events." That is, I want to own bonds that mature at different times providing a flow of cash (liquidity) to the portfolio. That cash flow allows for two things. First, a client may need to withdraw cash (other than the income from the portfolio) and rather than have to sell a bond (with the risk of a loss) it is nice to have a steady stream of maturing bonds. One of the great features of individual bonds (as opposed to bond funds) is that if you hold them to maturity you will get face value back on the final day (unless they default - which is rare in the investment grade universe that we invest in). In bond funds, the investor would be required to sell shares in order to withdraw principal.
Additionally, and more importantly, is that a variety of maturity dates helps us to manage reinvestment risks and opportunities, something most people don't usually think about. Let me provide an illustration. Suppose an investor's portfolio matured in July of 2011. The proceeds would then have to be reinvested at the interest rates prevailing at that time - which averaged about 1.50% for the 5-year Treasury in July. If, on the other hand, I had the portfolio structured out with bonds maturing over a period of years, then the impact of re-investing in the lower rate environment will be less disruptive to the income stream. So, a portfolio that has a greater variety of maturity dates (sometimes called a "laddered" portfolio, though we prefer to call it a structured portfolio for various reasons) will smooth out the impact of changes in interest rates on the income the portfolio will generate over time.
“Why should I hire a bond manager when I can ‘ladder’ a portfolio myself?”
I like to think that we bring a sense of discipline and experience to the table. I really don't like to use the term "ladder" when describing what I do. Laddering is simply buying bonds that mature each year for X amount of years. For example, a 10-year laddered portfolio would consist of bonds maturing every year for 10 consecutive years.
What I do is "structure" portfolios to capitalize on the current interest rate environment. This allows me to put my best foot forward and over-emphasize where I see value and to under-emphasize where I see less value. You know my saying – there is a lot more to bond investing than yield alone. Structure, quality, discipline and experience all matter.
When I'm looking for individual bonds for our clients, I have access to the offerings and inventories of more than two dozen dealer desks. Now some of those desks have a stronger presence in the taxable market versus the tax-exempt market and vice versa, but the point I'm trying to underscore, especially in the fractured muni market, is that you have to look carefully and thoroughly. And when I do, I can usually pick up a little extra yield for my efforts and that benefits our clients.
I will also selectively use callable bonds in a portfolio. The risk in a callable bond is that interest rates decline and the issuer "calls" the bond (meaning you have to surrender it back at face value) and then issues new bonds at lower rates (and investors are faced with reinvesting principal in that lower yield environment). However, you are rewarded for assuming the call-risk with a higher yield than on a comparable non-callable bond. There is value in callable bonds, but you are trading away an option for that value. Our typical portfolio has exposure to callable debt, but we do limit it.
“Your responsibilities previously included fixed income mutual fund research. Tell us about that.”
While I have talked at length about individual bonds with passion, I share that same feeling for bond funds. Believe me when I tell you that I fully recognize the merits of bond funds. They serve a distinct purpose and factor significantly in our portfolios for many clients. In addition, my skills as a bond manager have benefited immensely from my prior research duties related to bond funds. Through the process of mutual fund research, I have had the opportunity to meet many of the heavyweights in the bond business in an often free flowing exchange of ideas and outlooks. I can then turn around and mesh some of that knowledge gained with my own outlook and apply it to our managed bond portfolios. The mutual fund research responsibility now rests with some of my colleagues, but I still get involved with bond fund manager meetings from time to time. Whenever I do, I come away learning something new. This is another benefit to our clients.
“Where are you seeing opportunities in the bond market right now?”
I have had a bit of a struggle over the past few months searching for yield. The artificially low interest rate environment orchestrated by the Federal Reserve on the short end of the maturity curve and investor caution elsewhere have kept bonds well bid and, as a consequence, rates low. However, there are bargains to be had.
It is necessary to view rates not only in an absolute sense, but also in a relative sense. Absolute yields are low – there is no debate there. But when looking at corporate and municipal bond rates compared to Treasury securities and money markets, then you can better see the value. Believe me when I say I’d like to see a back-up in rates even though that would mean the value of some of our positions would diminish a bit. The clients and I would both welcome the appearance of higher yields. I would not be surprised to see yields begin to rise modestly, but by no means do I expect to see them rise dramatically.
“What is the biggest challenge you face in your role?”
As our Managed Bond Program has grown my responsibilities have evolved. As I mentioned previously, I am no longer responsible for the day-to-day research on the mutual fund side. That has freed up a significant amount of time that I now dedicate towards managing MBP. However, part of managing our bond program and just being “the bond guy” means making myself available to answer questions about current events in the bond market. And there are always going to be events. The challenge is giving up-to-date, accurate and useful information to those clients as well as searching for value in the bond market for the accounts I manage. Fortunately, we have several analysts here that are fully capable of pitching in.
In managing and trading our managed bond portfolios, no two accounts are identical, so what may work for client A may not work for client B and that adds up to a lot of detail. But with our trading systems, experience and a lot of hard work, it is all very manageable. The best part is that I simply love doing this job.
“What is the most important aspect of wealth management and the client-advisor relationship?”
That's an easy answer: know your client, know his or her expectations, and make them understand not only what could go right, but also what could go wrong. If you properly set expectations and provide a clear illustration of how to get there, everyone usually winds up satisfied.
“Thanks Chris!”
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