Investors fearing a market collapse are running into U.S. Treasuries, but they may soon rue the day they let fear dictate their investment decisions.
The financial rescue plan, which Friday was passed by Congress and signed by President Bush, will likely "accelerate" a stock market recovery, said Jim Lowell, partner and chief investment strategist of Adviser Investment Management Inc. of Newton, Mass., which manages $1.2 billion.
That will put pressure on Treasuries, the yields of which are so low that investors aren't being rewarded enough to purchase them, he said.
Yield on the three-month Treasury was at 0.03% Sept. 17: the lowest it has been since 1954. While it had climbed to 0.94% last Tuesday, that is still low.
"There's no value there whatsoever," said Stewart Taylor, a senior fixed-income trader with Eaton Vance Corp. of Boston. "It's terrible."
That hasn't slowed investor demand, however.
Intermediate-term government bond funds saw net inflows total $9.704 billion, short-term funds saw net inflows of $2.372 billion and long-term funds saw net inflows of $1.509 billion, year-to-date through Tuesday, according to Financial Research Corp. of Boston.
For the comparable period last year, intermediate-term funds saw just $83 million of net inflows, short-term funds saw net inflows of $1.518 billion, and long-term funds saw net inflows of $658 million, according to FRC.
"This flight to perceived safety has really crossed over into panicked buying," Mr. Lowell said. "The consequences will be dire when the markets turn."
Investors will get their money back, he said. But the purchasing power of those dollars — even dollars stashed in three-month Treasuries — will have been eroded, Mr. Lowell said.
"The only way that jumping into Treasuries is going to prove smart is if we enter a deep global recession," said Jay Hutchins, president of Comprehensive Planning Associates Inc. of Lebanon, N.H., which has $30 million in assets under management. "Treasuries lose under pretty much any other scenario."
Things are bad, but a deep recession seems unlikely, said Mike Kavanagh, a CFP with Atlanta-based Capital Investment Advisors Inc., which has more than $650 million under management.
"I am warning clients that Treasuries are overpriced, and you don't want to rush to Treasuries at the current price levels," he said.
"I think it may be prudent for many investors to consider moving [individual retirement account] cash into high-quality corporate-bond funds, especially some of the really good closed-end funds," Mr. Kavanagh said. "Another very attractive area for non-IRA money is municipal bond closed-end funds, where the spread between prices and [net asset value] is high and yields are extremely attractive."
Another possible alternative for risk-averse investors is money market funds, Mr. Lowell said.
While the reputations of many money funds took a hit recently, the temporary-guaranty program for money funds announced by the Department of the Treasury on Sept. 19 makes them a very attractive alternative to Treasuries, he said.
A brokered certificate of deposit, or secondary CD, is also a good alternative to Treasuries, said Greg Zandlo, president of the Zandlo Financial Group, a Minneapolis-based firm with $50 million under management.
Unlike a CD that is bought directly from a bank, a secondary CD is marketable in the secondary market. It is FDIC-insured up to $10,000.
That's not a bad deal when you consider that some secondary CDs — even short-term CDs — are producing twice the yield of money funds, Mr. Zandlo said.
Municipal bonds — particularly pre-funded muni bonds — are also attractive alternatives to Treasuries, said Jason R. Graybill, a senior managing director with Carret Asset Management LLC of New York, which manages $1.7 billion.
Pre-funded muni bonds involve lower risk because the issuer also purchases U.S. government securities that mature when its own bonds mature. The U.S. securities are placed in a special account. Essentially, that provides collateral for the muni bonds and an extra layer of security against default.
Another possible alternative to Treasuries, but one risk-averse investors may find hard to stomach, is short-term, high-grade corporate and agency debt, Mr. Graybill said.
For example, you can buy short-term bonds issued by Fannie Mae of Washington and Freddie Mac of McLean, Va. — bonds that since the firms were taken over by the government basically have a government guarantee — that yield between 2.5% and 3.25%, he said. That's much more attractive than what comparable Treasuries are paying, Mr. Graybill said.
Treasuries, however, aren't the awful investment some are painting them to be, said Samuel Scott, president of Sunrise Advisors Inc. of Leawood, Kan., which manages $130 million.
"By going to short-term Treasuries, investors aren't necessarily getting into treacherous territory," he said. "There is minimal risk in the shortest-term Treasuries."
Investing in Treasuries, however, may mean missing opportunities presented by a lower-priced stock market or by not receiving a slightly higher yield in other fixed-income investments, he admitted.
But the risk-averse may be all right with that, Mr. Scott said.
It should also be pointed out that investing in short-term Treasuries may yet prove to be the right decision.
"As cash is injected in the markets around the world and cheap money is made available, there will likely be some inflationary pressures in the future," Mr. Scott said.
Such an environment would theoretically favor short-term Treasuries, he said.
E-mail David Hoffman at [email protected].
