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Author: imcharliehm Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35345  
Subject: Corporate Bonds: a Buyer's Guide Date: 6/20/2002 2:34 PM
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The title is presumptuous, but the following, more accurate one wouldn't squeeze into the title box: “Some Tentative Thoughts on Buying Corporate Bonds Presented as a Set of Suggested Guidelines.” There are plenty of good introductions to bonds out there. (E.g., the bibliography pointed to by the following link http://www.bondvillage.com/ originally posted by Dan.) But they are all someone's thoughts and starting places, not my own. As Livermore suggests:

A man must believe in himself and his judgement if he expects to make a living in this game. If I buy stocks on Smith's tip, I must sell those same stocks on Smith's tip. I am depending on him…. I know from experience that nobody can give me a tip or a series of tips that will make more money for me than my own judgment. (Reminiscences of a Stock Operator, p.37)

The current market is a tough one to operate in, and my response, when things get tough, is to retreat to foundational things, reconfirm my principles and plans, and then get back in the game. So the following is just notes to myself, a summarizing of where I am at as I review and regroup. Be forewarned, however, that it won't be of much use to anyone else, because you are going to have to write your own investment/trading plan if you truly want to operate with “confidence and comfort”, as he councils:

A man cannot be convinced against his own convictions, but he can be talked into a state of uncertainty and indecision, which is even worse, for that means that he cannot trade with confidence and comfort. (Ibid., p.152.)

But my thoughts might be suggestive of the sorts of reviews you might undertake for yourself as fellow fixed-income investors, so I post them. Feel free to add, amend, revise, or reject the list of guidelines.
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#1 It doesn't take money to buy bonds, it takes data.

When I first got into the game of buying corporate bonds, I proposed the following rule to myself: Never buy the bond of a company that isn't publicly traded. Why? Because in addition to the feedback available about the prospects of the underlying company and their likely ability to pay interest and principal that would come from the bond rating houses and from the bond market itself by the way the bond was being priced, I also wanted the information stock analysts would provide about the company, as well as the pricing information the equity market would provide, plus easy and timely access to the SEC filings required of publicly traded companies. I wanted at least five sources of information. Subsequently, I've made some exceptions to the rule that have worked out as projected –e.g., Borden, Mrs. Fields—as well as missed a couple of good opportunities –e.g., Levi Strauss. And currently I'm faced with exceptions in the other direction: publicly traded companies whose bonds I'd like to buy, but for which I can't get SEC filings because they are foreign registered, e.g., Royal Caribbean, Air Canada. Pickings are slim these day, but my gut feeling is that trying to trade the exception rather than the rule will get me into trouble over the long haul. If timely and comprehensive data isn't available for the company –minimally, SEC filings and an actively traded stock-- , I don't buy their bonds.

#2 Making arbitrary thresholds as to credit quality might be a convenient strategy, but it's bad tactics if one is serious about bond investing.

The typical watershed is investment-grade vs. speculative grade, but it's a stupid dichotomy, because it over-emphasizes spurious differences. AAA's fail just as do CCC's . Not as often, but it happens, and unless one knows how to evaluate the underlying conditions that govern each in a scalar manner, one is going to be unpleasantly surprised sooner or later, both in terms of losses realized on holdings and opportunities missed . In my view BBB's is the riskiest category of all, because it's a transitional rating, offering putative safety but not compensatory yield, especially if the issue suffers a downgrade. What matters in buying bonds isn't rating labels, but reward/risk ratios, and one needs to know the tradeoffs across the whole credit spectrum in order to be able to properly price the bonds of each stratum. Furthermore, a persistent premium attaches to junk that the EM boys can't explain away despite two generations of attempts, and it is there to be captured.

#3 Proper position sizing and setting stops will not only compensate for a lot of research mistakes but are the most important investment/trading decisions to be made.
This is as self-evident as any of Euclid's postulates and requires no further comment.

#4 Sometimes bonds are expensive and sometimes they are cheap.
Knowing which is when is crucial to long-term investment success when investing in any asset class, not just bonds. Corollary: CD's are always expensive.

# 4 Bond funds are not bonds.
They are bond derivatives and must be traded as such.

I said this is tentative and I'm running out of steam. I'd add further guidelines another day. Feel free to add your own. Charlie

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