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Business Observer Thursday, Dec. 11, 2008 11 years ago

Bond Buyers

Forget stocks. Bonds are where the action is this year. Wasmer, Schroeder & Co. is one of the most skillful at picking fixed-income investments.
by: Jean Gruss Contributing Writer

These are times when bond managers prove their mettle.

From municipal to corporate and agency bonds, these money managers can take advantage of the current distortions in fixed-income markets to earn their clients a little bit of extra yield without taking on much more risk. That's where skillful managers such as Naples-based Wasmer, Schroeder & Co. add value.

The firm, which now manages $2.3 billion in assets, has a good long-term track record relative to its peers and benchmark indexes.

“In our mind, our clients want a fixed income manager to be conservative and be focused on credit quality and that is what they do,” says Gary Queen, an investment consultant with CapTrust Advisors in Bonita Springs. Tampa-based CapTrust is the state's largest investment consulting firm, helping high-net-worth individuals and institutions pick money managers.

The firm, which partners Martin Wasmer and Michael Schroeder started with money from friends and family, has grown by tapping into the multiplying ranks of wealth managers for high-net-worth individuals. With a solid track record, about 30% of the firm's assets now come from institutional investors, such as pension funds.

Today, clients of large brokerage firms such as Merrill Lynch, UBS and Smith Barney have access to Wasmer, Schroeder's funds. While most of the firm's business comes from wealth managers from around the country, one-third of its assets under management are from clients who have invested with the firm directly.

Now, Wasmer, Schroeder's assets could grow even more with a growing trend in wealth management called “unified managed accounts.” Currently, most investors have to create separate accounts for each type of investment, say individual stocks, bonds and mutual funds. A unified managed account combines all of these assets into a single account, reducing the complexity for managers and investors.

But for Wasmer, Schroeder, plugging into this system is complicated partly because of the technology and administrative work involved. Still, the payoff could be big. “The opportunity is in the hundreds of billions” of dollars, says

Michael Schroeder, president and chief investment officer of Wasmer, Schroeder. “We're studying it.”

Currently, Wasmer, Schroeder has a staff of 32 managers, analysts and other support staff, enough to manage $4 billion in assets from their offices overlooking tony Fifth Avenue in Naples.

The firm has demographics on its side. As Baby Boomers age, their tolerance for riskier stocks drops and they'll shift more of their assets to bonds. What's more, a new administration in the White House will likely mean higher income taxes, which encourages investing in tax-free municipal bonds for those in the highest tax brackets.

Schroeder says clients have been selling stocks and other appreciated assets in recent years in light of the probability of higher taxes and shifting the money to municipal bonds. But bonds haven't been immune from the risks of the market, so a manager's skill becomes even more critical in times like these. “From a market standpoint, it's very volatile,” Schroeder says.

Better returns, less risk
Successful bond managers are those who can deliver better total returns than their benchmarks and their peers over long periods of time. Total return is measured by a bond's capital appreciation and interest income.

For example, Wasmer, Schroeder's intermediate tax-exempt fund returned an annualized 3.38% over the last five years ending June 30, according to Informa/PSN data compiled by CapTrust for the Review (see accompanying table of Gulf Coast-based money manager performance). That puts the fund in the top quartile among its peers in that period.

Wasmer, Schroeder achieves these returns despite the fact that it takes on less risk than some of its competitors. Some managers take on extra risk by buying higher-yielding bonds with potentially more credit problems, which may boost their returns in the short term but hurt long-term total returns if the investments sour.

What's more, Schroeder says bonds that have performed better have longer-term maturities. “The portions of the yield curve that have done the best have been concentrated in a few maturities,” he says. That “sweet spot” of both capital appreciation and income has been in bonds that mature in the three- to seven-year span.

But measuring returns in the bond world is done in hundredths of percentage points. “The spread difference over three years between a median money manager and a top-quartile manager is only 30 basis points,” says Queen. One basis point is 0.01 percentage point.

The real value bond managers add is finding those issues that have solid credit risk in addition to decent yields. “We're not trying to outperform our benchmark every month or quarter,” says. “We're looking for value where there's little credit risk.”

For example, the firm recently bought Florida Board of Education 11-year general-obligation bonds with a yield of 4.25%. They're highly rated tax-free bonds insured by two bond insurers, including Warren Buffett's Berkshire

Hathaway. For individuals in the highest federal income tax bracket, that equals to a taxable yield of 6.54%. The bond insurance from Berkshire Hathaway makes them super safe. By comparison, a comparable U.S. Treasury note recently yielded just under 4%. “For our clients, we think it's a no-brainer,” Schroeder says.

Corporate minefields
Bond yields are measured by how much more they pay over super-safe U.S. Treasuries. This “spread” contracts in times of economic prosperity and widens during economic turmoil as investors demand higher yields in exchange for greater risk.

In times like these, some bonds tend to trade at a discount simply because of the negative publicity of some issuers. For example, the possible bankruptcy filing of Jefferson County, Ala., has unfairly tainted municipal bonds.

“Jefferson County is isolated,” says Schroeder.

Managers are careful to study an issuer's underlying credit in case a bond insurer can't pay in a default. Municipalities often buy insurance for their bonds. The added safety allows them to pay less interest and reassures bond investors. But recent bad news about bond insurers who strayed into risky mortgage-backed securities has raised concerns about their ability to back municipal issues.

But those concerns may be overdone. For example, Schroeder says bonds issued by the Atlanta airport are solid A-rated bonds despite the fact that a weaker bond-insurance company backs them.

What's more, municipalities will be converting billions of dollars of auction-rate securities to more conventional fixed-rate bonds in the years ahead. That means municipalities will compete to offer higher yields to entice investors.

Schroeder also believes that the worries over agency bonds such as those issued by Fannie Mae and Freddie Mac are overblown. While common and preferred shareholders should be concerned about whether any government bailout will wipe them out, there are no such concerns by bondholders. “The Treasury will guarantee the debt,” Schroeder says. In this case, why invest in Treasuries when you can get added yield by investing in agency bonds?

The bond arena Wasmer, Schroeder is most cautious about is corporate bonds. Despite some financial industry bonds yielding as much as four percentage points over Treasuries, Schroeder isn't tempted because of the risks.

Recently, the firm had 20% of its taxable bonds invested in corporate issuers, sticking to more solid companies such as ConocoPhillips, Dupont and Wal-Mart.

The last time corporate spreads were this wide, Wasmer, Schroeder held 50% of its taxable bonds in corporate issues. “I don't know if we'll get to 50% again,” Schroeder says.

The key to owning corporate bonds is to be well diversified. “Owning five banks is not diversified,” Schroeder says.

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