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The Market has Rallied--Now what?

Oftentimes, it may seem that the individual/retail investor is often among the last to enter and benefit from a rally. And, according to some experts over at Schwab, that seems to be the case this time. But, they still expect the market to continue its upward trend. Could it be that the market is indeed overvalued or do firms hold enough cash and other assets on their balance sheets to make this expected growth sustainable ?

Operating on the assumption that the market still has a way to climb, how does the late market entrant avoid ending up making speculative investments at these market highs?

Keep Floating Rate Debt on Your Boat’s Radar

Typically set to pay a fixed percentage above the current market rate (whether it be LIBOR, prime rate, or the federal funds rate), floating rate debt—however volatile the market interest rate may be—affords investors the possibility to not lose out on future rate increases. Anyone who holds cash in regular treasuries should consider switching to U.S. floating rate debt. And on the private sector side, note that current fixed coupon bonds cannot make up for the opportunity cost of buying at a later time or loss of principal the investor will potentially face when tapering begins. In fact, a source at Morgan Stanley believes tapering should begin next year. Floating rate debt may in fact be the investor’s best bet, under certain circumstances.

However, when speaking of floating rate funds, Jason Zweig of the WSJ warns that there are a few “…complication[s] that limit their buoyancy.” Given that closed-end funds issue only a fixed number of shares, some are now selling at a premium. They also tend to use leverage. While leverage has helped many of these funds pay out high dividends, it will conversely result in the funds borrowing at higher rates when tapering begins. New floating rate funds also have a “LIBOR floor,” meaning that LIBOR must cross a certain threshold before the funds’ yields can also increase. The only problem with this is that interest on their liabilities does not have a floor and is able to increase immediately. Another thing to consider is that such funds are junk bonds and carry default risk.

This means that investing in floating rate debt is a balancing act; but it is a balancing act that, when done well, can help the late entrant looking for income.  Here are a few no-load floating-rate funds worth considering:

  • CHIAX.LW: Credit Suisse Floating Rate High Income A—Priced at $6.98, yielding 4.33%. Except for the crisis in 2008, this fund has outperformed the Barclays Aggregate Bond Index. It consistently rode the market above its category, with far greater difference than many of its competitors. This makes sense given its standard deviation is over 3 times greater than the Barclays benchmark.
  • GIFAX.lw: Guggenheim Floating Rate A— Priced at $26.78, it has generally outperformed both its category and the Barclays US Aggregate Bond Index and its TTM yield is at 5.02%; but its inception was 2012. While promising, the prudent investor should wait to see how it performs by the 5-yr. mark, where the fluctuation between funds’ returns is narrower, but significant enough to see a difference. That being said, it is about two-thirds less invested in corporate bonds than the category average.   

Unlike many of the other funds listed under the bank loan category on Morningstar, these funds have at least performed near their indexes and categories and thus hint at lesser volatility. This, however, must be moderated by their inception dates.

Place a Bet on Convertibles

This will work best when the investor chooses a company that still has reasonable growth potential lying ahead. Given the fact that there is a built-in call option that can be redeemed above a certain threshold, companies are able to save money by offering lower rates than standard bonds. Just as importantly, investors are then able to benefit from equity appreciation. Some good, no-load convertible funds are:

  • FISCX.lw: Franklin Convertible Securities A—Priced at $18.00, 2.66% TTM yield. In over 10 years, this fund has outperformed its category almost every year since inception. It has returned almost 200 basis points above its category and performs with slightly more volatility than the rest of the market. It is the least correlated to its benchmark of the three on this list. It holds significantly more utilities and energy than its peers do. It has received a 4-star Morningstar rating.
  • VCVSX: Vanguard Convertible Securities Inv—Priced at $14.63, 2.37% TTM yield with a 4-star gold Morningstar rating. This fund invests fully in industrials with low credit quality and moderate interest rate sensitivity. It has the highest Sortino ratio of these three funds and standard deviation only 4 basis points over the category.
  • FACVX.lw: Fidelity Advisor Convertible Securities A—Priced at $ 30.71, 2.48% TTM yield. It is a large cap value investment, but its level of risk far surpasses what would seem reasonable for it category. Could this be partly due to its 15% greater investment in financials than the rest of its category? It holds Wells Fargo and Citigroup. Earlier this year Wells Fargo had to pare back its mortgage business, but not as hurtfully as other banks. Citi lost 90% of its share value between 2007-2012. Financial crisis aside, it has generally outperformed its category. Morningstar awards it a 4-star neutral rating. Focusing on its Sortino ratio, given its high standard deviation, it is only 3 basis points below its category. While this one may not be attractive as the rest, it was still among the better performing major player funds found on Morningstar.

Ride the Index, but not to its Dip

This means investing in an ETF, but one that is invested in defensives/acyclicals enough to weather a market correction. Schwab’s chief investment strategist, Liz Saunders, believes there may be an upcoming “healthy pull-back” before the market continues to rise. For the late entrant, he will need to reconcile his buys at premium by limiting his exposure to such an event. A prime example is the iShares High Dividend ETF (HDV). Trading at approximately $70, it is basically at its 52-week high of $71.24. However, it is well invested in sectors like consumer defensives, healthcare, communication services, utilities, and energy; and that is about 84% of the total portfolio allocation. The aim is to benefit from the expected rise while hedging for a correction.

In all, the late market entrant may find it difficult to find discounted securities. If he has to buy at a premium, he can at least offset this by satisfying his need for income and yield through floating rate debt; he can use convertible bonds to not be left out of market appreciation; and/or he can ride the index along with everyone else while weathering a market correction.


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Stock Tickers: Author Disclosure: Past performance is not indicative of future results. The performance numbers displayed herein may have been adversely or favorably impacted by events and economic conditions that will not prevail in the future. The indices discussed are unmanaged and do not incur management fees, transaction costs or other expenses associated with investable products. It is not possible to directly invest in an index. This information is not meant as a guide to investing, or as a source of specific investment recommendations. The information is general in nature and is not intended to be, and should not be construed as, legal or tax advice. The views expressed in this article are those of the author and do not reflect the views of his employer.