Great Ponzi.com

2009-06-18

This is not the time to chase yields (fixed-income)


Yields in fixed income

This article is written from the perspective of US and Canadian investment, but the same message applies no matter which country you are in. In these countries, the central bank's target overnight rate is close to zero. Treasury bill yields and savings accounts interest rates are also close to zero.

I am finding that with these low rates, many investors are trying to squeeze out an extra fraction of a percent by choosing vehicles such as corporate bonds over government bonds, or money market mutual funds over insured bank savings accounts.

I do not recommend chasing yield by going to riskier paper and debts. You gain just about nothing, but take on a lot more risk.

Risk and reward: 0.1% and 0.2% both round to zero

Money market (commercial paper) is riskier than government paper (t-bills, treasury notes). It was just a few months ago that commercial paper issuers had tremendous difficulty repaying investors holding the paper.

Money market is a dangerous place to park your money. You have a real risk of loss, and although some money market funds are insured, the government insurance does not apply to everything and is a temporary measure which may expire at any time.

Without question, money market and corporate bonds are riskier than t-bills and insured bank accounts.

Longer duration bank deposits are also inherently more risky than short duration deposits.

How about reward? Any time you take on more risk you should be enjoying more reward. The spread between the riskier debt and the safer option is very narrow. In my view, the situation is laughable: yields like 0.1% and 0.2% both round to zero.

Face it, either way you will earn nil interest

The reality of the day is that whichever option you choose, you will earn around nil interest on short term debts. Consequently, chasing yield is pointless and your main concern should be safety – not losing your money. I believe that the safest places to park cash continue to be insured bank savings accounts (CDIC in Canada or FDIC in the USA), t-bills, and other short term government bonds. Beware mutual funds and ETFs which claim to hold short term government bonds and t-bills, as my research shows that many of these mutual funds have questionable holdings and counter-party risk due to securities lending.

For bank term deposits (CDs and GICs), I suggest sticking to only the shortest durations.

Nothing beats government bonds held individually and directly in fully cash settled, non-margined accounts!



- Perpetual Bull