2011 Fixed Income Review

Back<<

With high levels of volatility in the equity markets, nearly all fixed income sectors posted positive returns in 2011.  In the 2011 first half, the Barclay's Aggregate Index, a broad measure of the fixed income markets, returned 2.7%, but that was not nearly as good as the 6.0% total return on the S&P 500.  In the second half, however, the Barclay's Aggregate earned 5.0%, compared with a 3.7% decline in the S&P 500.  For the year, the Barclay's Aggregate posted a total return of 7.8%, better than the S&P 500's 2.1%.

The primary drivers of superior returns were safety and long maturities.  Higher quality government bonds outperformed credit sensitive sectors; while returns on longer maturity bonds dwarfed those on short- and medium-term bonds.  The brightest spots for the year included long-term U.S. Treasurys (especially TIPS) and long-term municipal bonds which earned 34.0% and 14.4%, respectively.

Selected Fixed Income Benchmark Returns

Source:  Wall St. Journal, Lark Research calculations

U.S. Treasurys and TIPS
U.S. Treasury securities turned in a very strong performance, rising 10.0% in 2011, according to the Barclays index.  Returns were highest on the long-end, where issues earned an average 34.0% return.  Returns on the short-end were quite low, as yields approached zero.   Yields on the Barclays U.S. Treasury Composite Index fell by half during the course of the year to 1.0%.  Concerns about equities and fears of recession caused investors to seek the relative safety of the U.S. Treasury market.

Treasury inflation-protected securities or TIPS actually outperformed the straight Treasury market, earning a 12.2% total return in 2011, according to Lark Research estimates.  (See 2011 Market Returns on TIPS.)  Here again, longer-term TIPS posted much higher returns.  Investors were attracted both to the relative safety and inflation protection offered by TIPS.  However, yields on TIPS bonds closed the quarter near historically low levels.  Yields on short- and intermediate-term TIPS were negative, on average.

Agencies and Mortgage-Backed Securities
The mortgage-backed securities market, which is dominated by bonds guaranteed by Fannie Mae and Freddie Mac, earned solid, but markedly lower returns for the year.  Returns on agency securities (i.e. bonds that are actual obligations of Fannie Mae and Freddie Mac) earned 4.8%, near the bottom in terms of overall performance in the fixed income markets.  However, mortgage-backed securities earned 6.3% on average, according to Barclays.  Yields on agency and mortgage-backed securities declined by 50 basis points on average, but the spread between yields on those bonds and U.S. Treasurys increased by an estimated 20 basis points.

U.S. Investment Grade Corporate Bonds
High grade corporates performed solidly during the year.  On average, the sector earned an 8.2% total return.  Longer-term issues earned decidedly more than intermediate-term issues (15.9% vs. 5.5%) and lower quality BBB-rated issues more than AA-rated issues (9.0% vs. 7.1%).  Yields on investment grade corporates declined by 25-30 basis points, but spreads widened by 90-100 basis points.

U.S. High Yield Corporate Bonds
The U.S. high yield market underperformed most other sectors.  Total returns were 4.4% for the year, but lower quality issues (i.e. CCC-rated) posted a negative return of -1.4%.  The yield on the Merrill Lynch High Yield Constrained Index rose from 7.5% to 8.4% and spreads widened from 540 to 740 basis points.  Higher quality and liquid high yield bonds earned higher than average returns, as reflected in the 6.0% total return for Merrill's High Yield 100 Index.

Municipal Bonds
Municipal Bonds enjoyed a very strong year, with a total return of 10.6%, according to Merrill Lynch's Muni Master Index.  Within that Index, Intermediate-term and long-term municipal bonds earned returns of 13.2-14.9%.  Having underperformed most other fixed income sectors in the second half of 2010, investors sought out the attractive tax-advantaged yields and relative safety of municipal bonds throughout most of 2011.

Global Government and Emerging Markets
Global government bonds, as measured by the J.P. Morgan Index, earned 6.3% in 2011. meaningfully less than U.S. Treasury securities.  Performance by individual countries varied considerably, however, with Eurozone sovereigns earning only 1.8%, but Canadian government bonds earned 10.0%.

Emerging market bonds recorded an 8.5% total return in 2011, according to J.P. Morgan, which is somewhat surprising, since they historically tend to trade in line with the U.S. high yield market.  Recently, however, many of the BRICs countries have been seen as relatively safe havens, given their stronger expected rates of economic growth and, in most cases, acceptable credit profiles.  For the year, the average yield on the EMBI Index declined by 5 basis points to 6.08%, while spreads rose 20 basis points to 425.

Selected Fixed Income Benchmark Yields

Source:  Wall St. Journal

Returns on Selected Bond Mutual Funds

Source:  Morningstar via TD Ameritrade

For additional commentary on fixed income performance as well as ongoing analysis of stock, bond and mutual fund investments, subscribe to Income Builder, a newsletter published by Lark Research.  You can view sample reports and take advantage of a special introductory subscription offer at www.larkresearch.com/income_builder.htm.

January 12, 2012

Stephen P. Percoco
Lark Research, Inc.
P.O. Box 768
Norwood, MA  02062
www.larkresearch.com

(732) 763-0763
incomebuilder@larkresearch.com

© 2012  Lark Research, Inc.  All rights reserved.  Information is carefully compiled but not guaranteed to be free from error.  Reference to any specific security should never be construed as a solicitation to either buy or sell.  Reproduction without permission is prohibited.

Back<<

Please send your comments and suggestions to: webmaster@larkresearch.com.