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Subject:  Re: Building Bond Portfolios Date:  11/9/2002  7:49 PM
Author:  imcharliehm Number:  5149 of 36318


Would that obtaining yield with safety were that simple.

I understand the source of your suggestion, which is classic MPT theory, but I also think those guys are full of sh*t, for being rear-view mirror theorists, rather the "average" investors trying to manage retail amounts of money in real time without the admitted benefits of institutionally-sized research departments, institutionally-sized trading desks, plus the willingness to lie their asses off with tricks like end-of-quarter "window dressing" when their theories blow up and they have to make excuses about "relative underperformance" to their share holders. We real-world bond investors can't spend relative performance at the grocery store, and sometimes, maybe most times, the bird-in-the-hand promised by an AAA rating spends a lot better than chasing single A's. Mind you, I'm not saying to avoid single A's -- as I definitely would argue that any investor who wants to focus on investment-grade bonds should avoid triple B's. But I do think an over-weighting of single A's to chase a few basis point of yield is foolishness that will be rewarded by default. Increasing exposure increases risk.

I own some truly scary stuff, but I also own some very blue-chip stuff, because they serve different purposes, and anyone who grabbed Treasuries --which are better than AAA-- 2 years ago, and 5 years ago, and 10 years ago is sitting in the cat bird's seat today. Selecting for quality and safety doesn't preclude obtaining the best yields. As an example, let me quote returns from TR Price's most recently quarterly newsletter to their shareholders.

The 1/3/5/10 year returns for their SP500 index fund, PREIX, were (-20.64), (-13.09), (-1.88), and 8.65, resp. For their New Income fund, PRCIX, which is one place you'd see the single A's you advocate, the returns were 5.51, 8.17, 6.24, 6.39. Another place you'd see single A's show up is their Spectrum Income fund, RPSIX --normally stabilized by an allocation to equities but hurt in recent years-- with returns of 4.13, 5.00, 4.76, 6.97.

By constrast, their bluest of blue-chip bond funds, their U.S. Treasury long-term, PRULX, offered these eye-popping 1/3/5/10 year returns: 12.19, 11.53, 9.20, 8.37.

Yes, I'll freely admit those aren't the 20% plus returns equities offered annually '95-99 (which are historical shadows that few investors held on to), nor are they the fat yields single A's can sometimes offer -- from bouncing off bond market lows-- but those returns were steady across their time frames and offered substantive returns vis a vis inflation.

Summary: I wasn't advocating anything to anyone in my post, just exploring ideas, thinking aloud about where I find myself in the current interest rate cycle and wondering aloud what my next couple of moves are going to be. What makes sense to anyone else is for them to decide, including --for yourself-- an overweighting of single A's. But you also screw around with tobacco bonds, which I would never touch. So, at best, we are coming to the fixed-income table with very different ideas about risk. When I want "risk", I'll look it in the eye and buy it for what it is: stuff trading at recovery rates from a Ch 11 workout that offers 25-100% total returns if it doesn't fail (such that I can absorb huge losses across a portfolio of such issues and still end up beating the fund managers). But when I want "safe", I'm not going to compromise safety for a couple of basis points by trying to equate the known and proven safety of AAA's (with their nearly immeasurable default rate) with single A's with their miniscule but measurable one. The two aren't the same thing and don't serve the same purpose.

Balance. It's all about balance, just like planting a vegetable garden of spinch, radishes, onions, carrots, squash, tomatoes, etc. One year the sowbugs will get your carrots; another year the squirrels, your zuccinni; another year the birds, your corn. But every year you'll harvest enough to make a soup and a salad. The same is true of bond investing.

Steinbeck has a memorable short story in which a farmer puts his whole field into sweet peas and the weather gods and the market gods blessed him and he made a killing. But the farmer knew, and the reader knows, that every minute of that summer was a gut-wrenching risk until the crop as harvested and the cash was in his hands. Betting on single A's to the exclusion of the other investment-grades is planting your whole crop in sweet peas. It might work for a while, but it isn't a defensible long term strategy -IMHO.


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