The investment goals of the ultra-affluent individuals we serve at Paragon Capital Management, LLC are significantly different than those of typical investors. Capital preservation, tax-advantaged strategies, and a steady stream of cash flow are what many of our clients are seeking, and what Paragon Capital Management, LLC provides through our fixed-income investment strategies.
Fixed income refers to debt securities that can provide a steady stream of interest payments or dividends along a fixed schedule, hence the name "fixed income." The underlying debt security can be issued by many different types of organizations and is often used to fund a specific purpose.
Fixed-income investments are typically given preferential treatment over common stockholders if the debts become more than the issuer can maintain. While there are many different types of debt-based securities, they all maintain priority in bankruptcy proceedings over the owners of common equity shares.
There are many different types of fixed-income products, with each offering its own advantages and disadvantages. Treasury securities have provided the majority since 2012 and made up 37% of the fixed-income market in 2019. While they are the most popular, they are far from the only type of fixed-income securities.
Issued by the US Federal Government, treasury bills are a short-term way to invest in fixed-income securities, as they typically mature within one year. Investors buy treasury bills at a rate lower than the face value and earn the difference at maturity.
A treasury note can mature anywhere from two to twenty years and is also issued by the government. These treasury notes are sold in denominations of $100 and provide both principal and interest payments. A treasury note will pay semiannual interest for the duration, and the principal is returned to the investor when it matures.
Treasury bonds are very similar to treasury notes, except they have a much longer duration to maturity. Also purchased in denominations of $100, they don't typically mature for 20-30 years.
TIPS are a fixed-income security that protects the investor from inflation, by adjusting the principle to meet inflation or deflation. TIPS are sold by the US Treasury with maturities of 5, 10, or 30 years and pay interest every six months for their duration. This fixed-income security is capped at $10,000 per year.
The fixed-income securities listed above are issued by the US Federal Government, but state and local governments can issue government bonds as well. These debt obligations are typically taken on by state or local governments to fund projects and are broken down into general obligation bonds or revenue bonds.
General obligation muni bonds are often considered extremely safe because the issuer can raise taxes if they get into fiscal trouble. The same is not true for revenue muni bonds, however, which is why our fixed-income team at Paragon Capital Management, LLC typically does not use them for our clients' portfolios.
From 1970 to 2016 the default rate on 5-year municipal bonds was just 0.07%. These bonds also typically offer preferential federal and state tax treatment, with many offering tax-free interest income (although that can vary by state).
Credit risk is something to consider when seeking corporate bonds as a part of your fixed-income strategy, as the interest rates paid by the issuer will depend largely on their credit ratings.
Higher credit risk companies may issue high-yield bonds (also known as junk bonds) because their lower credit rankings require them to pay higher interest rates to attract investors. On the other side of the coin, investment-grade bonds come from companies with very low credit risk, but will also pay lower interest rates.
Financial institutions may offer Certificates of Deposit (CDs). With maturity rates of five years or less, these investments offer greater interest rates than a savings account or money market funds (but a lower interest rate than many investments that you will find in the bond market) and also carry Federal Deposit Insurance Corporation (FDIC) protection.
These fixed-income securities face liquidity risk. If you sell a CD before maturity, you will forfeit some or all of your interest.
Banks tend to vastly reduce their lending in times of economic turmoil, which can leave middle-market businesses seeking a way to raise money. There are approximately 200,000 middle-market businesses that have $10 million to $1 billion in annual revenue and need ways to raise capital when the banks aren't lending.
Private credit allows institutional investors to service those funding needs. These types of fixed-income securities are less liquid and may have a lock-up provision, but typically have a higher targeted distribution rate than public bonds.
At Paragon Capital Management we have access to these types of investments for our clients who meet the investment minimums to join our client list.
Structured notes can be an extremely beneficial part of a diversified portfolio. A typical advisor may suggest retail structured notes for your portfolio, but at Paragon Capital Management, LLC we provide our clients with access to wholesale structured notes, which are substantially different.
Because of our institutional relationships with the largest investment banks, our team is able to build custom-structured notes for our clientele that are hybrids. A hybrid of 80-90% fixed income and 10-20% options or derivatives, these investment vehicles utilize asset-backed securities with payoff profiles built to take advantage of rising, falling, or even range-bound markets.
If you don't know anything about bonds, but still want access to fixed-income products, you can opt to invest in bond funds. These funds are pooled investments (either a bond mutual fund or an exchange-traded fund (ETF)) that invest in bonds and other fixed-income securities.
Some bond funds only invest in investment-grade individual bonds. Others target junk bonds, some focus on municipal bonds, and other bond mutual funds invest wherever they can find the highest yield or the lowest taxes. These bond mutual funds may be actively managed (and may actively participate in the secondary market), while others are passively managed (buy & hold strategy). Some others are focused on taxes and invest in taxable or tax-free municipal bonds.
Fixed-income mutual funds are a good way to diversify if you are a normal investor, but for high-net-worth and accredited investors it is far better to work with a financial advisor who focuses on fixed-income products.
When people hear the term "stock" they usually think of equities or common stock shares. Preferred stock is a hybrid between common shares and bonds, and includes some characteristics of each asset class. These shares are ranked above common stock but below bonds in the event of a liquidation.
Preferred stock is typically paid through a fixed-rate dividend payment, which is often higher than the dividend paid on the same company's common stock. Different companies will issue preferred stock that will pay these dividends quarterly or monthly, and the dividend may be a fixed rate or adjustable according to a benchmark, often the federal funds rate. These shares can sometimes also be converted into common stock to participate in the upside of positive market activity.
One downside is that while common stock does typically come with voting rights regarding the direction of the company, preferred stock does not. Another downside is that a company is not seen as defaulting if they miss payments of the dividends for its preferred stock. Preferred shares are generally sensitive to interest rate risk, and there is a risk that the company will call in preferred shares (if they have a call provision) if the interest rates drop.
Investment advice will often place fixed income as merely an afterthought because it's far easier for some to sell their clients on the appeal of stocks or emerging markets that could have higher returns (and high transaction costs that go to the financial advisor).
At Paragon Capital Management, LLC we custom-build portfolios for each individual client, and fixed-income strategies provide a possible solution to reach their goals. Let's go through some of the reasons why our ultra-affluent clients often prefer fixed-income strategies.
A stock or mutual fund certainly has the appeal of unlimited growth potential or steady dividends, but it may also have a higher level of risk than other investments. Some asset classes can be very volatile and risk losing value quickly if the markets shift.
Fixed income is an excellent tool to manage capital preservation for our clients because, while there is a risk that bond prices fall, inflation risk, and liquidity risk, fixed income is still seen as a safer investment for capital preservation.
Municipal bonds provide tax benefits, with many of them providing both federal and state tax-free principal and interest payments. For our ultra-affluent investors for whom taxes are a major concern, fixed-income investments may provide a way to balance their portfolios with tax-advantaged strategies.
One of the greatest advantages of fixed-income strategies is the dependable cash flow that they can provide to our clients. Whether you want the money to be paid out to you, or to facilitate a "laddering strategy" that reinvests those principle and interest payments back into your portfolio, fixed-income products provide some of the most dependable, fixed-rate returns that are available.
While the federal benchmark interest rate may affect the bond markets, there are far fewer events to cause volatility in fixed-income than in the equity markets. AAA bonds have very little liquidity risk, while the same companies that issue those bonds may see their stock price drop precipitously due to market events.
Many fixed-income products come with guarantees, whether it be the government or the Federal Deposit Insurance Corporation. Even without the guarantee, a bank or corporation that fails to meet its debt obligation will face stiff penalties, lower credit ratings, and a higher interest rate on any future debt instruments that they create. Debt is the fuel of the global economy and what keeps companies growing and moving, so there have been significant regulations and guarantees put into place to ensure debt investors are protected.
While fixed-income products are mostly considered "safer" than some other asset classes, no investment is perfectly safe. Let's go through some of the potential risk factors that must be considered with fixed-income investing.
Corporate bonds may not have the guarantee of the government or FDIC, but do offer preferential treatment for debt holders over common stockholders if a firm cannot meet its debt obligations. US-based companies that issue debt have debt ratings, through which their required interest rates are determined, and investors can judge the credit risk for themselves. AAA rating is considered an investment-grade bond, while BB and below are considered high-yield (junk) bonds.
With fixed-income solutions, there is an interest rate risk that an investor will purchase a bond or bill, and the interest rates rise above its rate. This will cause the value of the instrument to lower in the secondary market, and the investor will be locked into that rate for the duration. The risk is not that the investor will lose money, but will lose out on an opportunity to gain a higher rate - although a laddering strategy will still take advantage of the higher rates when the oldest bond matures.
Except for Treasury Inflation-Protected Securities (TIPS), fixed-income investments do carry inflation risk. There is a chance that inflation rises higher than the fixed rate during the investment's life. A proper laddering strategy, however, will maintain a balance of short, medium, and long-dated investments, which will provide opportunities to get newer, higher-rate securities at regular intervals.
The current market price volatility within the stock markets has been a rude awakening for many investors who have only invested during a bull market. It has sent many seeking a safe haven, with some even moving all of their investable assets into money market funds and other places where the interest gained is extremely low, but they feel their savings are safe.
If you are an ultra-affluent investor who meets our investment minimums, our team at Paragon Capital Management, LLC would love to walk you through our fixed-income investing philosophy to explain how we build the future foundations of our clients' legacies.
Our portfolios are custom-built according to each client, their risk tolerance, and their investment goals. Those who meet our investment minimums are given access to unique products that are custom-built hand-in-hand with the some of the largest investment banks due to our institutional relationships with them.
The right fixed-income portfolio can provide a wealth of benefits on its own or as part of a diversified asset allocation. Contact our fixed-income team at Paragon Capital Management, LLC, and allow us to build a portfolio that is customized to help you achieve your goals.
Whether you feel as if you’ve outgrown your advisor or you just want a fresh perspective on portfolio strategies in our current market, our team of experts is here for you.
