Structured Certificates of Deposit (CDs)

As your investment advisor, we are held to a fiduciary standard.  Skipping the legalese and court cases which specifically define fiduciary, this means we act in your best interest in providing our investment advice.  This sounds obvious but many firms/brokers/insurance agents aren’t held to this tough standard.  They can, and will, sell you anything deemed suitable for you.  So, a lot of what we do with you is to get to know you, your financial situation, goals, and tolerance for risk when coming up with a financial plan and implementing that plan for you.  These are the proactive steps we take, the duty of care, in managing your investments.  And, this is an ongoing relationship as your financial situations changes throughout the years.  There is another aspect to how we manage money for you that you don’t see—and for good reason.  These are the investments you won’t see in your portfolio.  These investments might be entire asset classes, certain stocks, bonds, or funds, or insurance products.  Why? Banks, brokers, and insurance companies have invented all manner of suitable products which are either very expensive to you or seem too good to be true (e.g., upside to the stock market with no downside), or have hidden fees.  We hear these sales pitches often on your behalf.  So, we wanted to take this short blog post to highlight one of those products that was recently the subject of a page one article in the Wall Street Journal, the structured Certificate of Deposit (CD):

We will provide just a short summary here, but the article is worth the time to read.  With the bull market in stocks and lack of meaningful interest yields on low risk investments, Wall Street banks (i.e, Goldman, JP Morgan, Merrill Lynch, Barclays, etc.) have created structured Certificates of Deposit (CDs) to entice savers.  These are CDs linked to stocks or some other commodity, combining some limited upside and some limited downside, with guaranteed hefty fees for the salesperson and product creators. The CDs have very little liquidity if you need to sell before maturity, too.  The Journal’s analysis of 118 market-linked CDs issued at least three years ago by Barclays showed only a small number exceeding the returns an investor would have earned on a conventional FDIC-insured (risk free) CD.  If the product being sold to you has a long fancy name like “GS Momentum Builder Multi-Asset 5 ER Index-Linked Certificate of Deposit Due 2021,” a real structured CD, and disclosure documents which run hundreds of pages (most do), alarm bells should be ringing in your head.  You won’t see NWIC buying these in your portfolio.

Stock markets around the world have sold off and volatility has spiked

While you should receive our detailed year end newsletter soon, we wanted to quickly reach out to you to provide our thoughts and action plan.

First off, up until last summer US stock markets have been rather subdued with no correction (more than 10% down) in a few years. Even the dramatic decline in the price of oil which began mid 2014 had been orderly up to late last year.


China is probably the best explanation with the strong Dollar a contributor too. We have written about both of these before as well as covering the drop in oil in one of our quarterly economic updates at the beginning of 2015. We said you should expect the price of oil to stay low for a while, and that consumers would benefit and eventually spend some of the windfall.

We would boil this market correction down to changing expectations for corporate earnings this year. We don’t see a recession in the US or anything approaching 2008-2009. So take comfort from that. The US only exports something like $120 billion in goods directly to China. Also, interest rates are not increasing to any degree such that this would change how investors capitalize earnings or pose competition for investor dollars. Inflation, too, is still on hiatus. The drop in the price of oil is far from being a negative for our economy. The drop in gasoline prices alone added $134 billion to consumers’ pockets (more than total exports to China) in 2015 versus 2014. So, no recession here unless you live in oil country.

Even without a US recession global companies are exposed to slowing conditions abroad. For example, around half of the sales of companies in the S&P 500 index are from international markets. So Investors are concerned that corporate earnings will not measure up to what was expected in 2016 with the world economy slowing. They’re probably right. With the Dollar up, US firms can become less competitive and earnings abroad translated back into Dollars will be lower than expected just last year. And as we wrote in our year end newsletter, stocks are expensive and probably priced for perfection.


Take a close look at the chart below of S&P 500 profits per share since 1960 and the S&P 500 index value. (The red line shows earnings, and the blue line represents price.) Through war, recession, whatever, never before has the S&P 500 price and earnings failed to find a bottom and recover. This time will be no different–be patient.


The sell off has made some of the companies we own buys again. Many have been holds to use Wall Street jargon. And we have been able to add a couple new names in the industrial sector that we think are high quality and now good values –MSC Industrial Direct in the Smaller Companies portfolio and Rockwell Automation in Equity Income. We are looking for more. You can read more about those additions in our year end newsletter. Most of you, too, have a large portion of your portfolio in bonds. Bonds are up over this period of volatility as investors seek safety.  That’s the benefit of diversification.

So again, please be patient but don’t hesitate to call or come in if you have questions, concerns, or your circumstances have changed that may impact your tolerance for risk in your portfolio. 

The securities mentioned are not the only securities we have purchased in the last year for our clients. If you would like a list of all securities purchased in the last year, please contact us. Additionally, it should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities mentioned.

Positive Vibes

The probability of a rate hike at the December 16th FOMC meeting, as calculated by the market, now stands at 80%. Whether it actually takes place in a week, or whether the move takes place at one of the next two meetings, the consensus is that short-term rates will move higher soon. We have written over the past months, and even years, not only our view of when the Fed will raise rates, but also what the impact will be on the most rate-sensitive area of most portfolios: bonds.

Just yesterday I received an email that was likely similar to emails you have been receiving lately, from one of the many financial services firms who have taken it upon themselves to save our fixed income portfolios. The subject header read, “Is your fixed income portfolio prepared for rising rates?” The first line, in bold, warned me, “It’s the interest rate risk inherent in fixed income: when interest rates rise, bond values fall.” Based on the severity of warnings such as these, that we have all been subject to through news media outlets and the marketing divisions of asset gathering financial companies, I decided to do some digging to see just how “at risk” we truly are with regard to bonds.

In actuality, my “digging” involved updating a chart to which I like to refer that I think should relieve those concerned about rising interest rates. The chart below, using data compiled by Morningstar’s Ibbotson SBBI 2015 Classic Yearbook, shows that even during long periods of rising interest rates, US intermediate-term government bonds rarely exhibit negative returns: (Click on the chart for a larger version)

Negative Returns Uncommon

While the long explanation for these welcome results is related to duration and convexity (i.e. more is gained from a fall in yield than is lost when interest rates rise), the shorter answer is that total returns from bonds comes from a capital appreciation component and an income component. In a bond portfolio that is properly laddered and/or managed, maturing bonds are reinvested at higher rates, so that over time, higher rates mostly offset capital losses, even during rising rate periods.

An even more positive chart (pun intended) explores what happens to bond returns with longer holding periods. This data, also provided by the Ibbotson SBBI 2015 Classic Yearbook, demonstrates how holding assets for long periods of time has the effect of lowering the risk of experiencing a loss of capital: (Click on the chart for a larger version)

Long-term positive returns

Throughout these 5-year rolling-periods there were times where interest rates undoubtedly rose for an extended length of time. In spite of rising rates, bonds have demonstrated a remarkable ability to preserve capital when held judiciously and through full market cycles.

It should be noted that here at Northwest Investment Counselors we invest primarily in corporate and US Government Agency debt securities. Agency bonds tend to move almost in lockstep with US Treasuries due to their implicit government guarantee, the major difference generally being the structure of agency bonds, many of which are callable, compared with plain vanilla, non-callable Treasuries. The above trends, while similar for all high-quality, investment grade bonds, are likely somewhat different for corporate bonds, with the notable difference being the higher return volatility of corporate bonds. Since they are inherently riskier, the returns in good years will be higher, and the negative return years will see more capital depreciation. Nonetheless, well-researched corporate bonds will offer many of the same portfolio stabilizing characteristics of US intermediate-term government bonds when held for long periods, while in most cases providing a higher level of income.

Please contact us directly to learn more about the contents of your bond portfolio specifically or to hear about our various fixed income solutions that provide income while also matching cash flow with liabilities.

Retire.Ready: Spotlight on the Bond Ladder

Clients near or in their retirement years consistently express three primary financial concerns:

  1. Do I have enough money?
  2. Is my cash flow predictable?
  3. What if I have an emergency?

Our Retire.Ready solution addresses these concerns. We believe those nearing retirement should transition from a pure total-return approach to a hybrid total-return and liability matching strategy to reduce risk while managing retirement cash flow. The Retire.Ready solution consists of three important components:

  1. In-depth financial assessment that creates a retirement budget
  2. Social Security optimization
  3. Portfolio divided into three financial buckets including unique 10-year bond ladder to match future cash flow needs (see diagram)

Just like our long-standing, traditionalbuckets portfolios Retire.Ready utilizes high-quality bonds. Uncovering attractive yields is always an important goal, but safety and predictability are the cornerstones of the Retire.Ready bond ladder. It takes a prudent investor to know when to pass up the siren call of even slightly more yield in favor of capital preservation. This is a tradeoff we take to the next level.

Our traditional total return portfolios that incorporate our intermediate fixed income securities are designed to be extremely safe, but also maintain a manageable amount of risk, to increase income responsibly. In our intermediate fixed income composite, we have the flexibility to target an array of credit ratings across either a range of maturities or a more consolidated timeline, as long as we feel comfortable with the overall diversification, yield, and safety. Our in-house research points us towards companies with wide economic moats and strong balance sheets, but also towards companies whose competitive advantage is based more on economies of scale in competitive, low barrier industries. We prefer companies with strong management teams and high cash flow generation, but our research allows us the flexibility to favor unusual credit metrics over others, such as a company’s ability to tap the credit markets, cut large historic dividend payments, or divest less profitable business lines. Our internal, rigorous, and evolving due diligence is our advantage in finding individual bonds that we feel confident will mature at par, all while providing higher than general market yields to maturity.

Retire.Ready takes a slightly different approach. The typical bond portfolio risks, be it interest rate risk, reinvestment risk, or headline risk have been reduced by a bond ladder designed to match our clients’ upcoming liabilities. The bonds in the ladder won’t always be the highest yielding bonds in a particular credit sector, due to our prioritizing of safety, and will in most cases be held to maturity. Though we plan to hold bonds to maturity, this is not a “set it and forget it” portfolio or high priced annuity. We continue to monitor the portfolio, be it corporate or municipal bonds, to ensure the persistent high standard of credit quality we recognized when the bonds were purchased. Retire.Ready bonds will benefit from institutional pricing and also the nimble nature of our bond desk to find mispriced “odd-lot” bonds when appropriate. The Retire.Ready portfolio will make use of corporate, agency, and municipal bonds to find the right mix of credit quality, tax-efficiency, and income. Please contact us to learn more about what goes into the Retire.Ready portfolio and how it may help you to be and feel more secure financially.


If you missed the live showing of our Private Wealth Management series on managing retirement cash flows and optimizing your Social Security strategy, here is a link to the replay on YouTube.  If you want a copy of the slides, please contact us.

The securities mentioned are not the only securities we have purchased in the last year for our clients.  If you would like a list of all securities purchased in the last year, please contact us.  Additionally, it should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities mentioned.

Retire.Ready Private Wealth Management Series

Here is a picture from our Retire.Ready presentation this morning.  We will have a video summary up soon for those who missed the presentation.  Thank you to all who attended and thank you Christel Turkiewicz, CRPC and Matt Roehr, CFA for presenting our retirement solution.20150519_162008819_iOS Please follow us at @NWInvestment or @NWRetireReady to stay informed.

Retire.Ready Private Wealth Management Series

Please join us on May 19 for our latest Private Wealth Management Series on our Retire.Ready service.  Are you prepared for retirement?  Have you prepared a budget plan?  Have you considered strategies to maximize your Social Security?  How should your portfolio be structured to meet your retirement cash flow needs and still be sustainable, predictable, and flexible?  Matt Roehr, CFA and Christel Turkiewicz, CRPC will lead the discussion on this important topic.  Space is limited and filling fast so RSVP today to Theresa O’Donnell at 503-906-9624 or



What Inflation?

For some time now we’ve been hearing worries about the inability of most bonds to keep pace with inflation. Because bonds are “fixed” income investments, the ability to exceed inflation is a major concern, especially in a low interest rate environment. The truth is, despite what your grocery bill may look like, inflation is actually quite weak right now. The core consumer price index (CPI) which excludes food and energy, is currently running at 1.8% year-over-year as of October, less than the Fed’s 2% inflation target.

Well what about inflation expectations, or future inflation, you ask?

The 5-year break-even inflation rate, calculated by subtracting the yield on a Treasury Inflation-Protected Security from that of a nominal US Treasury note is currently 1.48%, the lowest it’s been since October 2011. This implies investors expect inflation to average 1.48% annually over the next five years, in-spite of years of a near-zero Fed Funds rate and massive quantitative easing by the Federal Reserve.

Recent inflation readings, despite an uptick in US GDP (normally inflationary) since the starkly negative growth from Q1, have quieted both inflation hawks on the Federal Open Market Committee and economic pundits alike. Data from the Chicago Mercantile Exchange’s FedWatch indicates the market expects the Fed, whose dual mandate is full employment and stability of prices, to raise rates towards the end of 2015, as opposed to the first or second quarter as previously believed.

What factors are contributing to low inflation and potential continuation of accommodative monetary policy?

Among others, weakening worldwide economic growth is likely the largest factor. Weak growth and the expectation of greater quantitative easing by the European Central Bank (ECB), has pushed Eurozone sovereign debt to record lows (the German 10-yr yields 0.74%!). Improving US economic conditions and a global search for yield has made the US an attractive place for foreign investors, whether in Treasuries or riskier domestic investments. The stronger dollar also makes foreign goods, and as a result domestic goods, cheaper for American consumers. Although energy is not included in core inflation, oil, and as a result gasoline, is also cheaper. Another factor is tepid wage growth, even in the face of solid employment gains in the US, which is seen as both a consequence and cause of weakening inflation.

What does this all mean for bonds?

As yields around the world stand at or near record lows, with the potential to go lower if the ECB begins buying sovereign debt, it’s hard to expect domestic interest will rise the way most investors and economists expected heading into 2014. This sounds like more frustrating news for bond investors, but there is a silver lining! The purchasing power of a bond’s coupon is enhanced as inflation falls, which is definitely something to feel good about. We continue to seek bonds with justifiably higher yields than peer bonds of similar rating and maturity using a fundamental approach.

Go Big or Go Home? Not So Fast!

NWIC_logo 4Value comes in all shapes and sizes in the world of fixed income. Unlike the stock market, availability of the bonds you like can be limited and offerings might even disappear from the secondary market during the time it takes to conduct proper research. The scarcity of coveted bonds can have several varying effects on the price of a bond. A small bond issuance of a desirable company may be in short supply, and consequently, have higher prices for those investors wishing to own the bonds. Another scenario is that the bond is in such short supply, and trades so infrequently, that when bonds do become available, they trade at wider spreads (lower prices) than their credit rating and appeal suggests. We often target bonds of this nature because we can add yield safely by essentially providing liquidity to the market. Investors who become crunched for cash for one reason or another may find themselves needing to sell one of these small, infrequently traded bond positions. When this happens, small listings (10-25 bonds) will show up on one of the several bond platforms and inventory lists we view daily. In order to move this bond inventory, which is too small to raise the interest of mutual funds, dealers must “mark down” the price to entice those buyers willing to do the research and purchase a small position. These small bond lots, which we call “odd-lot” or “spinach” pieces, offer the buyer anywhere from a few basis points (a basis point is 1/100th of 1%) more than a comparable bond to spreads in the 20+ basis point range.

At NWIC, we view the ability and know-how to buy odd-lots as a huge advantage for our clients. Investment firms smaller than ours rarely have a devoted bond manager with the time to sort through many small issues and either buy bond funds or more expensive new issues. Investment firms that are much larger operate more like mutual funds themselves and often miss the bargain odd-lot pieces. Most dealers will even say first hand that for bond pieces smaller than $100K, there is significantly less fund demand, making those bonds cheaper and preserving their availability to a degree.

As always, there are several caveats. For the same reason we are able to buy these marked down odd-lots at cheaper than normal prices, we strongly reinforce the buy-and-hold principle. Trying to sell one of these pieces prior to maturity can lead to a mark down on the sell-side. Not to fret! Our portfolios contain a diverse array bonds across the corporate, municipal, and government sectors to ensure that we are adding yield over and above going market interest rates while also preserving the bedrock characteristics of a safe and liquid bond portfolio.

It is also important to point out while there is value buying small lots, we also attain institutional pricing for individual clients by leveraging our ability to buy much larger quantities of bonds than is typical for single accounts. If this sounds contradictory to our appreciation above for small quantities, remember that the bond market is a much more fragmented market than the stock market, and that what may be available or cheap now, may change in only a matter of minutes. Finding good deals may take on the form of providing liquidity to other investors who need to sell a rarely traded bond, or doing the homework to find out why a larger issue appears cheap relative to comparable investments.

Below are two examples of odd-lot bonds. One demonstrates the benefit of odd-lots while one presents an area of caution. (Bear in mind that due to the nature of odd-lot bonds, the bonds described herein may not have been purchased directly for your portfolio. If your account was not a recipient in one round of odd-lot purchases, it will likely be a recipient in the next round, should your allocation levels warrant a bond purchase):

1) Juniper Networks 3.1% 3/15/2016 (Baa2/BBB): The most active corporate bonds will have trade amounts in the millions of dollars per day. As we mentioned above, sometimes a good name, such as Juniper Networks will show up as an odd-lot. We recently found a 35 bond lot ($35,000 par value) available and purchased it at an attractive price and yield. This trade was on July 18th and was the only trade that day, a thinly traded bond for sure. The bond was purchased at a yield to maturity of 1.03%, a spread of 55 basis points to a two-year Treasury (despite being just a 20 month bond). We view this as a strong credit that owing to infrequent trading was purchased more cheaply than a comparable bond, or even the same bond had there been more trades on that day.

2) Metropolitan Transit Authority 5.5% 7/1/2017 (Aa2/AA+): As we discussed in an earlier post “What are These Bonds in my Portfolio?” we buy odd-lot municipals that are pre-refunded and backed by US Treasuries. This bond happens to be escrowed to maturity, which is like pre-refunding, but takes place upon maturity as opposed to an earlier call date. At first glance, this bond is a very safe municipal bond, backed 100% by Treasuries and offering a 2.11% yield to maturity on a tax equivalent basis for investors in the highest income bracket. This represents a spread of 116 basis points to a comparable Treasury, despite the fact that the credit is identical (the credit is identical to a Treasury but this bond would be less liquid). The Schwab listing for this bond only shows a yield-to-maturity, which normally implies that what you see is what you get, in this case an annualized return of 2.11%. Further digging into the SEC filings for this bond reveals a more concerning reality. This bond is subject to a sinking fund call (I won’t go into that definition right now but it is another way for an issuer to take back a bond from its holder prior to maturity). The research for this bond involves reading the footnote of an SEC filing from 2002 which states:

2002 Footnote

Footnote two is the relevant one here and indicates that we can lose the bond prior to maturity. After plugging the offering price into the sinking fund analysis page of our Bloomberg software, we get a yield to the sinking fund call date of -0.73%. It’s hard to say for sure whether this bond will be subject in the end to the sinking fund call, but it would be ill-advised to buy a bond that has even a small likelihood of a negative return.

These examples highlight two of the many ways we seek to create and add value for our fixed income clients and also how our research and relevant knowledge shapes our conservative investment decisions.

The fixed income securities referenced above are not the only fixed income securities we have purchased in the last year for our clients.  If you would like a list of all fixed income securities purchased in the last year, please contact us.  Additionally, it should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.