Truly a “Balancing” Act

This week I want to focus on a topic that has come up often in recent conversations: investing the “safe” portion of a portfolio when there are no more “safe” assets… or at least, no safe assets that provide a reasonable return. As our clients know, we do not believe the “balancing” portion of an asset allocation should be subject to the ebb and flow of market volatility—at least, not to a meaningful degree. So where do we invest our ballast when the return on those investments gets so small it can hardly be called an investment?

The once-reliable, steady asset of your portfolio—U.S. Treasuries—has been the grown-up in the room for the last few years (or longer, depending on your view). But what happens when that grown-up starts acting more like a moody teenager? What was once a stalwart of return and low risk is now showing some cracks. Add to those cracks interest rate yields that are falling and a yield curve that is basically flat. Oh, and investment-grade corporate yields look VERY similar. So, today’s investors are rightly asking: where do I invest the fixed income part of my portfolio when traditional bonds aren’t pulling their weight?

Glad you asked! (It’s almost like I made up a question that perfectly segued into my next point—almost.) At East Franklin Capital, we help investors think beyond the conventional—especially when the conventional no longer serves its purpose. Below, we’ll explore options for the income-generating, low-correlation, true balancing piece of your portfolio—without sending you diving into esoteric hedge funds or putting your hard-earned money into financial products designed (mostly) for the person selling them to you.

The Job of Fixed Income in a Portfolio

Let’s not forget why we hold fixed income. The most common answers to “why do we even own bonds?” are: generate consistent income, preserve capital/principal, and act as a hedge against equity market volatility.

When Treasury yields are skimming the floor, corporate bonds offer little premium for their risk, and correlations trend with the stock markets, it might be time to rethink the tools—but not the goals. U.S. Treasuries are safe, generally, but yields are falling and may soon be less than inflation (which means you’re slowly going broke safely). Investment-grade corporate bonds offer a slightly (barely) better yield for most maturities, but are often highly correlated to economic cycles and still vulnerable to rising rates.

And lastly, bond funds may be sensible for diversification, but they trade daily—translating to more volatility than many investors bargained for, especially in rising-rate environments.

So Where Can You Turn?

One word: MATTRESS! (Kidding.)

Okay, assuming you want more return than your mattress… here are a few options that can work for risk reduction or ballast. In fact, generally, the investment lineup below checks a handful of important boxes for the balanced portion of a portfolio: low correlation to equities, steady income (possibly variable but generally consistent), and historical stability when markets get choppy.

1. Individually Laddered Bonds

If bond funds feel too volatile, we often look to a laddered portfolio of individual bonds. The benefit? You control the maturity dates and credit quality and can simply hold to maturity—smoothing out market noise and reinvesting principal as each rung matures.

We have done this almost entirely with Treasuries in the recent past, but there are additional high-quality options available as well.

Pros:

• Works well with Treasuries or high-quality corporate bonds

• Offers predictability and control

Cons:

• Takes some active management and a larger upfront outlay (i.e., hard to ladder a $40K bond portfolio)

2. Municipal Bonds (Munis)

Particularly appealing for high-income investors, municipal bonds can deliver solid after-tax yields and tend to have a low correlation to the equity market. When purchased individually, they can also provide price stability and predictable cash flow.

Advantages:

• Tax-exempt income (often federal and state)

• Generally low default rates—especially for general obligation and essential-service revenue bonds

• Individual bonds held to maturity can mitigate volatility

Risks and Drawbacks:

• Interest Rate Risk: Like all bonds, municipal bonds fall in value when rates rise—though this is less of an issue if you hold them to maturity.

• Credit Risk: While defaults are rare, they do happen—especially with revenue bonds tied to specific projects (think toll roads, stadiums, or convention centers). And states aren’t exactly great at meeting their budgets… I mean, California, are you even trying?!

• Liquidity Risk: Thin trading means it may be harder to sell at fair value if you need to exit early.

• Call Risk: Some municipal bonds can be called before maturity, limiting your long-term yield.

Bottom line: Municipal bonds can be a great fit, but credit selection matters.

3. Preferred Securities

Think of these as a hybrid between stocks and bonds. Preferred shares in public companies can offer high income (sometimes 6–7% yields), sit above common equity in the capital structure, and often have low day-to-day correlation to equities.

Good income potential
Some call risk (being functionally repurchased from the investor early) and credit risk
Can be bought individually or in ETFs (with volatility caveats)

We focus on investment-grade preferred shares or those issued by financially strong institutions, but note that preferred stocks can correlate to their more flamboyant cousin (equities).

4. Private Credit / Direct Lending

This investment “alternative” is getting a fair amount of press—and for good reason. Private credit involves lending directly to businesses (often small or medium-sized companies that have a harder time getting access to bank loans) in exchange for higher yields than public debt markets.

Are these companies inherently riskier than larger ones? Hard to say, but the market seems to think the additional return could be worth the additional risk. This might just be an example of a gap between public lending options and bank lending options that is being filled by private investors.

Private credit is often accessed through a fund, thereby offering some diversification.

Highlights:

• These loans are typically floating-rate, which can be a good inflation hedge

• Low correlation to public equities and bonds

• Requires access via funds and due diligence on liquidity and underwriting standards

This investment type has grown rapidly, which means quality varies. Who you invest with—and through—definitely matters.

5. Defensive Options Strategies

Many of you know that options are a tool we’ve used at East Franklin Capital more or less since our inception in 2012. The fundamental income-generating alternative using options is often a covered call strategy—where you own the fund (or stock) and sell away a portion—or even all—of the upside in exchange for cold hard cash on day one.

The cash received generates current income, and this can be repeated multiple times per year as the calls expire. Think of a covered call strategy as a chance to trade away upside for income—and meaningful income in many cases.

You still own the underlying investment (fund or stock), so you have some correlation to the market—but less than you would have without the call options.

Key points:

• Underlying security selection is key, and the strategy should be managed and monitored

• Better as “income diversifiers” than bond substitutes, as market risk is quite real

• Best utilized in non-taxable accounts, though can be effective in taxable ones as well

Options strategies can play a role in the income sleeve of your portfolio, but they’re not replacements for fixed income. A defensive covered call strategy should be implemented as a supplement, not a substitute, for core fixed income.

The Key: Diversification Within the Defensive or “Balance” Portion of Your Allocation

Without a truly “safe” investment asset, we see the opportunity to build a mosaic of income-generating assets that complement each other—so when one zigs, another zags (or at least the volume on the volatility is turned way down).

Think of this part of the portfolio—the “balance” in a balanced allocation—that was once dominated by a single asset or two (e.g., Treasuries or investment-grade corporate bonds) as now being more of a group effort. This new team—a mix of players that once had smaller roles—must be tailored to your tax profile, liquidity needs, and risk tolerance.

We’re not saying goodbye to fixed income—we’re saying it’s time to be nimble and diligent. The right mix of assets can still offer income, capital preservation, and diversification. But in this market, how you hold fixed income is just as important as what you hold.

As Treasuries and their investment-grade corporate siblings generate lower and lower yields, we think that for the foreseeable future, there might be a better way.

Want to dive deeper into any of these strategies?
East Franklin Capital specializes in building resilient, diversified portfolios that keep working for you and your goals—even when the bond market isn’t.