Taxable Bond Commentary
Safety in Quality

Taxable markets are behaving quite differently than last year. As economic and credit market conditions worsened over the course of 2008, stock prices fell sharply, dramatically widening yield spreads of quality-sensitive corporate bonds to their Treasury counterparts. This prompted us to systematically reduce exposure to vulnerable corporate sectors and opt for the safety of U.S. Treasuries. By year end, Oakwood clients reaped relatively generous returns and enhanced portfolio liquidity, while capturing valuable investment management flexibility.

Edging back to corporates

We have reversed our stance this year by investing in attractive corporate bonds—primarily in food, agriculture, transportation, and select banking sectors. Examples include McDonald’s, John Deere, Monsanto, Union Pacific and J.P. Morgan. In the network solutions area we hold Cisco Systems.

As corporations reorganize, reduce inventories, and write-down troubled assets to transition from “damage management” to future growth, investment opportunities are beginning to surface. This is not to suggest that the wave of bad news is over, but that we feel the time is right to increase yield on client portfolios. Recent purchases include Paccar and Pfizer. We will seek others as the year progresses.

Foregoing growth for capital preservation

As shown in the following chart, US Treasury yields remain at very low levels. We feel it wise to limit longer maturity positions, although longer maturity yield levels are notably higher than short maturity yields. A 2-year Treasury yielding a meager 0.84% may be a better investment choice than a 10-year Treasury at 2.67%. Clearly, investing in short-term Treasuries may be a bad idea for investors seeking higher return; what it buys, however, is capital preservation.

While the 10-year Treasury at 2.67% offers additional yield, market risk to principal must be closely monitored. The Federal Reserve has made clear that it will purchase a substantial amount of longer Treasuries should yields rise to a level that threatens fixed-term home-mortgage rates. Should 10-year yields again rise to a level above 3.00%, we will selectively add to longer positions. As these yields move to 2.50%, we will take gains and reduce our exposure. Our goal is to add value as the markets search for a new long-term direction.

Overall we favor lower coupon securities in the short maturity area to limit reinvestment of coupon cash flow in the current low-yield environment. In contrast, we favor above-market higher coupon securities in the longer maturity area to counter any risk of price erosion should yields suddenly move higher. We stand ready to quickly alter our present market view should the seemingly excess stimulus to the economy by Congress and the Federal Reserve increase the risk of inflation.