A quarter-point rate swing in either direction can deliver an unpleasant surprise, says Daniel Dektar, portfolio manager at Smith Breeden Associates. If rates plunge, home refinancings and prepayments of mortgages underlying a CMO will speed up. You'll get some of your principal back sooner than expected and will have to find new ways to invest the cash at lower rates. In an added twist, many recent issues are doubly callable. This means that besides the prepayment risk, there's a chance that institutional investors with options on the underlying mortgages will call your entire issue.
Junk bonds are easier to comprehend and shine with mainstream acceptance.
Gross, like many bond pros, recommends shunning domestic high-yield debt now. Lower rates will aid issuers, but that will be of little help if the economy slows sharply and defaults rise. He also worries that the fallout from Asia could jeopardize companies' earnings and ability to pay down debt. And if you want junk to provide a hedge against a stock market decline, think again. The yield spreads over Treasuries aren't high enough to compensate an investor,'' says Daniel Fuss, managing partner for fixed income at Loomis Sayles.