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Author: charliebonds Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35362  
Subject: Barnhill’s Book Date: 9/18/2010 12:24 PM
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In a forum in which I occasionally post, someone asked the following question:

The book "High Yield Bonds: Market Structure, Valuation, and Portfolio Strategies" by Theodore Barnhill et al is going on 13 years old soon, and I am noticing that there is a serious mark-up on the copies one can find online. Does anyone know if they are planning on an updated version? If not, does anyone know if it is worth the $150 price tag? I would love to get into this area of investing, but I am having some misgivings about purchasing a 100% marked-up book that is 13 years old without seeing it. Any thoughts?

The question was asked in June, but I hadn’t stopped by in a while, just as I don’t stop by here very often, for being too busy with other things (like fishing) or for having little interest in the topics generally discussed. But the book is one that I’ve often recommended to people wanting to learn about bond investing, so I made the following reply.
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I see that the price of the book has gone up a bit since you asked about its merits. In fact, it has gone up quite a bit. The asking-price for a new copy at Amazon is now $295, with used copies available at $192.85. That doesn’t compare very favorably to the $75 price on the inside of the dust cover, nor the $40 I paid for a used copy many years ago. http://www.amazon.com/High-Yield-Bonds-Structure-Strategies/... The age of the book has little impact on the usefulness of its information. Its 28 chapters are thematically related, but each can stand alone as being a good place to get a thoughtful, non-mathematized intro to topics like:

-Do Seniority Provisions Protect Bondholder's Investments?
-How Many High Yield Bonds Make a Diversified Portfolio?
-Historical Default Rates of Corporate Bond Issues, 1920-1996.

But much of the same info can be found in the white papers that Moodys makes available, or in the anthologies on fixed-income edited by Fabozzi, or from other sources on the web, such as Investopedia. If you really do want to see a copy, then ask your local library to borrow one through their Inter Library Loan service. The book is a fun and useful read if you are an experienced, fixed-income investor. If you aren’t, then I'd suggest you begin with Cohen’s book, Bonds Now! http://www.amazon.com/Bonds-Now-Making-Income-Landscape/dp/0...

I'd also suggest that if you aren't already buying your own high-yield bonds, then you don't know enough to get involved with them at this very late stage in the rally. You are at least 15 months too late. You're going to be buying at a top, and you're going to get killed, because you won’t be buying at the sorts of discounts needed to create a margin of safety. That phrase, “margin of safety” suggests another book that you should read and, in fact, the one you should be buying, Ben Graham’s classic intro to value-investing, The Intelligent Investor. The 4th edition, with a used price of $4.92, is exactly where you should begin your investigations into high-yields. First, learn how to do value-investing, then apply those concepts to high-yield bond investing.

Yes, the returns offered by high-yields have been fabulous this year, as some of my purchases and their gains will suggest:

<b<ISSUE         CPN    DUE      BOUGHT   P/L
Hanson 6.125 08/15/16 04/02/09 123%
AMD 6.000 05/01/15 04/20/09 118%
Xerox 0.570 04/21/18 11/02/06 103%
Nations 0.000 01/10/28 07/13/09 102%
E*Trade 7.875 12/01/15 04/21/09 97%
Ford 6.350 04/21/14 08/01/08 87%
Seagate 6.800 10/01/16 02/06/09 83%
Ford 6.750 06/20/14 07/10/08 82%
Alcoa 5.870 02/23/22 04/13/09 79%
Zions 6.000 09/15/15 04/09/09 74%
UnionCarb 7.875 04/01/23 02/19/09 70%
Westinghouse 7.875 09/01/23 01/30/09 62%

However, if you look at the trade dates, you’ll see that most of them were bought in the dark days of spring-summer 2009 when uncertainties were high. But I knew I was seeing bargains. So I bought bonds, adding 75 new positions that year and about 80 more so far this year. But as anyone who buys his/her own bonds will tell you, the low-hanging fruit is long gone. Bonds are in a speculative bubble that isn’t going to end well for the Johnny-Come-Lately amateurs.

If you do want some exposure to the asset-class, then do so through a high-yield fund or a multi-sector bond fund and trail a tight stop. Meanwhile, do your reading, thinking, and poking around. The asset-class is hugely interesting, and it offers serious money. But high-yield investing, like every type of investing, is a specialization that requires a lot of effort and a lot of capital. When there is buying to be done, I'm easily putting in 20 hours a week, running my scans, doing my due diligence, keeping up with the back-office work of running a bond portfolio (close to 300 positions, spread across $500k or so, only a portion of which is high-yields). Right now, of course, and for the past several months, I haven't had to put in those kinds of hours, and I've been able to do some fishing. But still, if I'm not putting in a couple hours of shopping/researching at least three mornings a week, I'm missing too many opportunities that do need to be considered, even if most of them are eventually rejected.

Investing is a job. Investing is a business. Pick --of the hundreds there are or can be created-- the one where the odds of success for you are the best, given the skills and resources you can bring to it, the chief of which will be temperament, not capital. (You've gotta like what you're doing.) That might well be high-yields for you. But right now is a very tough time to break into the game. As anyone who is already in the game will tell you, prices are insanely high, which is why profits are so insanely high. That situation describes a high-risk top, not a low-risk bottom. High-yields have to be bought cheaply --when everyone is scared to buy them-- or else the risks of the asset-class cannot be properly managed. You've gotta get in cheaply enough that your inevitable mistakes can be absorbed by the excess premiums you also earn, which is what the naysayers always forget. They point to egregious cases like WHOOPS or Enron and say "investing is too high-risk". So, instead, they do genuinely high-risk things, like buying principal-protected instruments (CDs, TIPS, etc.), and then fail to understand why their purchasing-power is being eroded faster than their capital is growing.

Losses are an annoyance, but they are nothing that can be avoided. Therefore, they have to be off-set by profits that offer a real-rate of return after taxes and inflation. Therefore, risks have to be accepted. But “Risk” never has to be wallowed in. That's what people who point to WHOOPS bonds or Enron stock always forget. No single mistake will get you thrown out of the game, nor will even a series of mistakes cause serious harm, provided that positions are properly sized.

Why did WHOOPS bonds offer a high yield? Because they were high-risk bonds. In a properly-managed bond-portfolio, what is the maximum position that could be held of that issuer? About 2%. Not 5%, not 10%, not one's whole 401k, as those idiots at Enron did with their own company's stock. You don't walk into the casino and bet the farm on red, nor do you ever play any investment game (except for entertainment) in which you can't prove (at least on paper) that you won't have a positive expectancy, on average and over the long haul. And "long haul" isn't a hot quarter or two, or a decade or two, which the passive-indexers always use and have gotten nowhere in the last decade with their strategy. (Which is a rant for another time.)

Yes, do your reading. Yes, do your preps. Set up an account at E*Trade and learn how to do bonds scans. Then write a very detailed business plan and stick to it. That's how success with the asset-class will be achieved, the old-fashioned way: by buying WHAT should be bought, WHEN it should be bought, in the AMOUNT it should be bought, and then doing it over and over again, week after week, year after year. That's all junk-bond investing is. It's just classic value-investing, exactly as Ben Graham described it.

Charlie
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Author: RHinCT Big red star, 1000 posts Ticker Guide SC1 Red Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 31492 of 35362
Subject: Re: Barnhill’s Book Date: 9/18/2010 2:30 PM
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My favorite tool for locating hard to find books is used.addall.com. I just put that title in there and found two at around $70. One is an electronic edition so you don't have to worry about someone else snatching it out from under your nose!

http://www.powells.com/biblio/0071376968?&PID=531

One note about using AddAll - it combines many sources, and many booksellers subscribe to multiple services. It is VERY common for one copy to appear multiple times in the AddAll list.

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Author: JustMee01 Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 31494 of 35362
Subject: Re: Barnhill’s Book Date: 9/18/2010 7:15 PM
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I just found a very cheap copy of Security Analysis. Thanks for that link. It's now bookmarked.

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Author: duronron1 Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 31495 of 35362
Subject: Re: Barnhill’s Book Date: 9/19/2010 12:39 AM
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The cost of a used book may not indicate the importance of a book. It often means the first printing was very small.

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Author: charliebonds Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 31496 of 35362
Subject: Re: Barnhill’s Book Date: 9/19/2010 12:45 PM
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Frankly, I’m surprised this post has earned a favorable reception, given that its intent was more provocation than instruction. But my point about the necessity and benefits of a sound investment plan were right on the mark.

Ten years ago, in the hay days of the tech bubble, when everyone and his cousin was throwing money at every no-earnings, piece-of-trash IPO brought to market and making a killing, I said to myself, “there’s gotta be a better way to make a few bucks from markets, because the current frenzy can’t end well.” So I started poking around in bonds, and I was surprised by what I found. The debt of companies with tangible assets and good-enough earnings was being discounted enough to offer a real-rate of return (after taxes and inflation). The yields weren’t even half of those offered by tech stocks, but they were good enough. So I dug into the asset class, and served my apprenticeship.

Now, a decade later, that choice seems wise. According to whomever wrote the article in this week’s issue of Barron’s on PIMCO’s roll-out of a mutual fund dedicated to global junk bonds, ”junk bonds have out-performed stocks over the last decade with 54% less volatility.” I haven’t yet had time to check the truth of his assertion. But doing so should be straight-forward. Just pull the data from Yahoo Finance on the relevant benchmarks and then import it into Excel and infer their respective volatilities from their standard deviations, which Excel will compute.

But that was then, and now is now. Is junk-bond investing still a good idea? I’d argue it is, and for the same reason it was a good idea back then. There are two ways money can be made in bonds: by betting on the direction of interest-rates, and by betting on the direction of credit-risk. The two are related. As interest-rates rise or fall, credit-risk (in a general sense) is exacerbated or eased. But what really matters to a credit-risk bet is the issuer’s specifics, just as what matters to a stock bet is both the broad economic picture but, more so, the company’s specifics. Thus, success in either depends on good due-diligence, with the former being more forgiving, due to the fact that bondholders stand higher in the credit line than equity holders and the fact that bonds mature (aka, are a put). Therefore, for a stock bet to do well, the company has to do well. But for a bond bet to do well, the company merely has to survive. That’s a lesser goal, and with it comes lesser returns, of course, on average, about 3.5x less. In other words, if you can expect to make 7% from a bond bet, buying the company’s common ought to offer around 25% over the same holding-period but, also, with proportional greater volatility.

So that’s the trade-off. Either bet is risky, but one is more worrisome. Right now, of course, due to demographics and a lot of other factors, money is flowing out of stocks and flooding into bonds, distorting valuations in ways that can’t end well. But if stocks are what one knows, then one sticks with stocks, just as if bonds are what one knows, then that is what one sticks with, because trying to change horses in mid-stream will offer the worst of both worlds: selling low and buying high. So my advice remains the same. Figure out who you are and then pick an investment method that matches your personality and stick with it. Financial success has little to do with the supposedly-objective numbers and nearly everything to do with how you will manage the risks of making decisions under conditions of uncertainty. In other words, how you manage Fear and Greed will determine your success, and the only way to deal with them in a rational, productive is with an investment plan that is based on who you are as an individual human being with a unique personality and temperament.

In creating a plan, you aren't trying to convince yourself you aren't scared of losses. You should be scared of them. The plan enables you to deal with your fears so that you can make probabilistic bets which are likely to pay off, on average and over the long haul, just as your plan also serves to keep greed in check so you aren't making bigger bets than is prudent, on average and over the long haul. In short, the purpose of an investment plan isn't to make the best money for you that might be achieved, but to keep you in the game long enough that you can learn the game well enough that good-enough returns can be achieved. Or as Buffet has advised on many occasions, "Don't do anything brilliant. Just try to avoid doing anything really stupid, and you'll make money."

Charlie

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