|High Quality Cash Equivalent
Many investors are quite concerned about the over-indebted, precarious outlook for the U. S. capital markets, but they have little interest in money market funds yielding virtually nothing. In fact, they would like to invest in a high quality, cash equivalent alternative that would be interest bearing and provide low volatility. Lang Asset Management is now able to offer a product to meet these objectives through their Cash Alternative product that minimizes risk in a very uncertain environment, and also provides a high level of liquidity.
We accomplish these objectives by purchasing individual fixed income securities maturing in six years or less, that are high grade (AAA and AA), and that generate yields averaging three to four percent annually. This is a unique niche market within the fixed income market because most of these bonds have call features that cause them to have a higher yield than bonds without this feature. If the bonds are called, the yield from the broadly diversified list of called bonds is reduced to approximately 3%, still significantly greater than 0.01% from money market funds. And the total bond portfolio posts a superior quality return of about AA+. Other than U. S. Treasuries, it is impossible to develop a list so exceptional.
Most investors have never heard of this arcane approach (like pre-refunded or escrowed to maturity AAA bonds). All portfolios are well diversified, as each position size represents only 5% to 10% of the total value of the account. Therefore, when fully invested, portfolios will hold between 10 and 20 individual issues. We do not utilize mutual or commingled funds.
Our overriding philosophy in the management of our fixed income portfolios is to provide capital preservation, while providing income, if needed. This is done through the purchase of individual U.S. Treasury Bonds and Notes, and AAA and AA corporate and/or municipal bonds, depending upon the client's tax bracket. We also limit our maturities to 1-6 years, which limits risk from large interest rate swings. For instance, if interest rates rise, losses are minimized since the bonds will soon mature.
Currently about 75% of our assets under management consist of individually managed (as opposed to pooled) bond portfolios. These accounts include individuals, retirement plans, and IRA's. Our concern about the highly-leveraged economy, and our commitment to preserving principal, demand that we limit our fixed income holdings to only the highest quality instruments. All bonds that we purchase are limited to AAA and AA ratings. Typical names include Johnson and Johnson, Exxon, Nestle, and Microsoft. Yet in spite of maintaining the highest quality bond portfolios, we have generated very competitive results over time. Additionally, risk is held to a minimum by ensuring that the portfolio is well-diversified. Each individual bond holding only represents 5% to 8% of the total bond portfolio. No subprime, insured or CDO securities are held.
An unusual circumstance is apparent at this time with respect to municipal bonds. Their interest rates are generally higher than taxable bonds (corporate bonds, c.d.'s, etc.). That is, the traditional condition is now reversed, which has been that taxable bonds have yielded more than tax exempt bonds. So, as long as we maintain the highest quality, we are pursuaded that tax exempt bonds are now more attractive from a yield point-of-view, even in account types that traditionally did not buy them (IRA's, pension and profit sharing accounts, etc.). Nevertheless, some clients may prefer corporate bonds only, and that is certainly acceptable.
For the year 2016, this product generated a return before fees of about 3.0% (2.92%). After fees the return was 2.4%. It is virtually impossible to achieve such a return unless one lengthens the average maturity (to 10 years) or accepts much lower quality (BAA). For instance, the yield from the two and one-half year U.S. Treasury notes is only 1.38%.
Here are the following portfolio parameters for this product:
Average yield -to-maturity 4.14%
Average maturity 2.62 yrs
Average Duration 2.35 yrs
Average Coupon 4.58 %
Average Quality (S&P) AA+ (Only one notch lower than the very top grade AAA)
For taxable accounts, an added bonus is that the income is tax-free since virtually all the issues held are municpal bonds. Thus, a 2.4% return equates to approximately a 3.5% net return before taxes depending on one's tax bracket.