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Author: folgore Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35400  
Subject: Last high yield bond bargain? Date: 9/9/2010 7:02 PM
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As Charlie has stated before, the first half of 2009 was a golden age during which to build a high yield corporate bond portfolio. Investment grade bonds were yielding much higher than normal and junk bonds were selling at extraordinary discounts that made the added risk in investing in them worthwhile.

Unfortunately, I only purchased one batch of Prudential bonds during that golden moment. It yielded 10% and was rated in low A's -- investment grade. Since then, I've been chasing yield albeit while accepting greater risk. My bond portfolio is, therefore, largely based on junk bonds. (The batch of Prudential I purchased was called early!)

To try to up the average quality of my bond portfolio, I set the Etrade search engine to the low end of investment grade. The highest yielder is Tenneco Packaging Incorporated. They have three sets of bonds yielding 9% plus. They are rated Baaa2/BBB, but these rating date back to 2002! The parent company of Tenneco is Pactiv (PTV) which itself is being bought out by Reynolds Group Holdings. (The makers of Reynolds Wrap.)

My inclination is to think packaging is a pretty secure industry regardless of the state of the economy. Anyone have an opinion on Tenneco's bonds?
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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: 31469 of 35400
Subject: Re: Last high yield bond bargain? Date: 9/9/2010 9:16 PM
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Folgore,

I know nothing about Tenneco Packaging as a company, and there’s plenty of people who post in this forum who are way better industry analysts than me. So my comments on possibly buying Tenneco’s bonds will have to be of a general nature. By way of doing that, let me take violent exception to your lament that you didn’t purchase more of Pru. Rear-view investing doesn’t deserve a second thought. In early 2009, there could be no assurance that prices wouldn’t continue to plunge and that the whole economy wouldn’t go down. And it would have self-destructed if the Fed/Treasury “Plunge Protection” team hadn’t stepped in and hadn’t begun buying behind the scenes in early March.

Yes, in early 2009, we were seeing what seemed to be bargains, and anyone who considers himself or herself a value investor should have been doing some buying. No matter the uncertainties, some buying had to be done. If a person wants to claim that he or she is an investor, he/she has to “walk the walk”, which meant doing a judicious amount of buying, but not so much that ruin would ensue if one’s timing were wrong. Thus, any position initiated had to be small, or else one was just gambling. Yes, in retrospect, all of us would have done well if we had “backed up the truck”. But that is a sure recipe for disaster over the long haul. Betting bigger than is prudent will pay-off far fewer times than sizing positions prudently. Given the uncertainties at the time, the purchase of a single bond was justified, and, depending on one’s account size, maybe 5 to 10. But nothing bigger, as it is easy to show from game theory.

In other words, using realistic date in which the absence of evidence isn’t evidence of absence, how many times over 100,00 market cycles would over-buying the dips have been the best strategy?

That’s hard to compute, right? So let’s take a simpler example. You’ve got $1, and I’ve got $100, and let’s flip for pennies. If your bet size is a penny, you are likely to walk away neither a significant winner, nor a significant loser, even if we play all day. But if you increase your bet size to two bits, I’ll take all of your money within minutes. “Markets”, as Keynes shrewdly observed, “can stay irrational longer than you can stay solvent.” Therefore, if one intends to be an market survivor, rather than just a “here today, gone tomorrow” gambler, bets have to be smaller than would have been retrospectively optimal over a short time-frame like one lifetime, or two, or ten. But betting properly will ensure survival even if the game is run over another 10,000 life-times. So, yeah, you made good money on Pru, this time, and this time you would have made better money if you had bet bigger. But are you really willing to risk blowing up your account by reaching for that extra bit of return? Isn’t it better to identify where the danger zone is and then back off a notch or two?

Where misinterpretation and misapplication occurs is in identifying “risk” solely with default-risk. Thus, the supposedly “risk-adverse” avoid credit-risk, which is obvious and easy to identify, but they downplay the destructive effects of inflation-risk. So, yes, some Pru should have been bought, as well as some Alcoa, some Budweiser, some Cat, some Delta Gas, some E*Trade, some Ford, some GE, etc., right down the alphabet and right across all sectors and industries. Because that was the macro-bet being made. “If the economy does recover, I want to be positioned to benefit from it.” And it didn’t make a bit of difference whether the bet was done from the stock-side, or the bond side, or both. The bet had to be made, and it had to be properly sized. In other words, it had to be done in a disciplined manner that would tolerate failure.

That’s what most investors don’t understand. The goal of investing isn’t to build a plan that has no faults. The goal is to build a plan that can tolerate one’s inevitable mistakes, misjudgments, and a fair share of bad luck, the future being the unknowable thing it is and markets being the capricious, vindictive things they are.

As for Tenneco, be very careful to distinguish between "agency-assigned credit-rating" and "market-implied credit-rating". My bet is that Tenneco isn’t investment-grade. It’s a junk bond, and it has to be managed as such right from the getgo.

Charlie

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Author: jackcrow Big gold star, 5000 posts Feste Award Nominee! Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 31470 of 35400
Subject: Re: Last high yield bond bargain? Date: 9/9/2010 9:41 PM
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As for Tenneco, be very careful to distinguish between "agency-assigned credit-rating" and "market-implied credit-rating". My bet is that Tenneco isn’t investment-grade. It’s a junk bond, and it has to be managed as such right from the getgo.

Where value might lie is in the buyout. If the purchasing company is healthier then Tenneco the market may have not noticed yet. There is also the possibility that if the purchasing company has the means and the covenants allow they will finance so YTW calcs are probably the smart math to start with.

http://www.reuters.com/article/idCNWLA255420100909?rpc=44

Couldn't find much else with a quick search.

Did find this tho

http://www.reynoldspkg.com/reynoldspkg/default.asp

If you follow the New Zealand billionare Graeme Hart you might get a bit of insight. Seems he has been on a 3 year buying spree within this industry. It seems he owns the group so a direct look at his balance sheet or the balance sheet of the holdings isn't likely.

jack

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Author: folgore Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 31474 of 35400
Subject: Re: Last high yield bond bargain? Date: 9/12/2010 10:59 AM
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A belated thanks for the replies!

Charlie, I too, tend to think of Tenneco as a junk bond. When I first started putting real money into bonds in 2009, I thought any credit rating that proceded the fall crash of 2008 to be out of date. Now that I'm finding ratings that haven't been updated in almost 10 years, I'm not sure what to think. Does that mean Moody's and S&P have forgotten about these bonds for whatever reason? Or does it mean the old rating is still valid? I assumed they re-rated the bonds of major companies on a regular basis. If a bond's ratings remains the same, do they re-release the result to indicate that the credit rating for X Corporation is still the same? Or do they publish new ratings for a corporation only when the rating is a change, either up or down? Oh well...

Jack, studying up a bit about Graeme Hart does seem the best if imperfect and indirect way to research Tenneco. Given the necessary if dull nature of the packaging industry and the fact that Hart owns much of it, it's hard to imagine a major default on Tenneco's bonds occurring. The most serious concern would be an early call which wouldn't be disastrous since the bonds currently sell at something like a 10% discount on par.

The pickings are definitely getting slim. When junk is selling at par, I have to assume that the bond market is currently overpriced.

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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: 31475 of 35400
Subject: Re: Last high yield bond bargain? Date: 9/12/2010 3:23 PM
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When I first started putting real money into bonds in 2009, I thought any credit rating that proceded the fall crash of 2008 to be out of date. Now that I'm finding ratings that haven't been updated in almost 10 years, I'm not sure what to think. Does that mean Moody's and S&P have forgotten about these bonds for whatever reason? Or does it mean the old rating is still valid? I assumed they re-rated the bonds of major companies on a regular basis. If a bond's ratings remains the same, do they re-release the result to indicate that the credit rating for X Corporation is still the same? Or do they publish new ratings for a corporation only when the rating is a change, either up or down?

Folgore,

Possibly, some of your questions might be answered by poking around on the raters' websites, or by searching some of the generally excellent articles to be found at Ivestopedia.

Here's how I think about the "timeliness" problem. S&P and Moodys are for-profit businesses, not free, public services. Companies pay the agencies so they can get rated. A high rating means they can borrow more cheaply than a lower-rated company. So they have every incentive to fudge their books, and GAAP rules are flexible enough that they can generally do so. If the agencies throw the company a sweet-heart rating, they are more likely to get repeat business from them. So they have a lot of incentive to collude.

However, if their ratings depart too far from reality, then they would lose credibility, not that that seems to worry them much, given that they also have a lawful monopoly on the ratings business. Therefore, the only discipline is the market itself. How are the bonds being priced? If a nominally-rated invest-grade bond is being priced to yield junk-bond yields, then, obviously, it is probably really is a junk bond.

A classic example of the divergence between "agency-assigned" ratings and "market-implied" ratings was GE and the yields it offered. A couple years back, GE was rated Aaa/AAA. But the yields implied something closer to triple-BBB. Subsequently, both S&P and Moody notched them down a bit, though not as low as they should have for political reasons and/or bribes, to their present Aa2/AA+ (or whatever it is). But it is still easy to see that they are over-rated by doing constructing comparative yield-curves.

And it isn't just me who uses this technique. If you poke around with Fidelity's bond search engine, you'll be presented with output that is rated in terms of whether the issue is a "risk-outlier", meaning, the yield offered is inappropriate to the nominal rating.

I don't remember if Fido runs their proprietary calcs in both directions, but it is easy to reverse-engineer them and do so. Sometimes, bonds with nominally low ratings are offering very little yield. Why? Because the market, in its infinite wisdom, "knows" the issue is a better credit than it appears to be, and it is pricing it to reflect that fact.

Is "the market" always right? Ha, fat chance. Do S&P and Moodys always get their ratings wrong? Ha, fat chance. My guess is that they get things right about 85% of the time, as does the market. It's that 15% that can make or break an investor, depending on the skill with which he/she knows "which is when" and can also size position so that one's inevitable mistakes don't cause out-sized damaged.

In short, use agency-assigned ratings and market-implied ratings the same way you use a weather report. By and large, they can be trusted. But a prudent person also takes a look out the window for him/herself, and he/she also carries an umbrella when it makes sense to do do.

So the "bottom line" seems to be this. Anyone who can't do their own credit-analysis is a fool to depend solely on agency-ratings, because, sooner or later, they are going to get themselves into more trouble than they can manage. "We wuz lied to" they will protest. "We wuz robbed."

"No", is the only proper reply. "You failed to do your due-diligence, and now your are paying the price of your greed, stupidity, and laziness."

Charlie

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Author: brucedoe Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 31476 of 35400
Subject: Re: Last high yield bond bargain? Date: 9/12/2010 6:25 PM
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Charlie

I know a lot of people like to Poo-Poo GE, but we bought a 25 yr bond of theirs in 2004 paying 5.13%. I felt we needed to get at least 5% interest so I felt this qualified. Well after 6 years, GE is still around and paying the interest on the bond. And it is paying 1.3% more than I could get on a 30-yr Treasury, even better if you want to compare it to a 20 yr Treasury. For some reason it is a couple hundred dollars below par according to Schwab but 5.13% is fine for us under this environment. I have no idea what the rating of GE should be. So far as I can remember , they have not had a losing quarter of earning so far. Besides, if the rating should be BBB, that does not mean it will fail. We own lots of REIT preferreds that have rating from BBB+ to BBB-. This is true even for a REIT like PSA that has no debt, though they have a lot of preferred stock to service. This preferred is just a tad below par but we bought it much lower so we could sell at a profit if we wished. And the common stock has been hitting new 52-week highs lately (We own no common stock).

We also have a GE Internote paying 6.25% bought 2-1.2 years ago that matures in 2027. This note is a few percent over par though it is paying 2.4% over a 30 yr Treasury. We'll settle for that risk.

I don't know if GE will be around in 2027-2029, but I doubt we will be as we are at or pushing 80. If there is a problem, it will be for our heirs. Yes, yes, I know, raging inflation is coming, but I have been expecting it since 2001 and know not when it will come. I presume it will come some year, however. Right now, though Federal debt is increasing scarily, total borrowing is going down. I find it hard to believe there will be raging inflation under these circumstances. Deflation seems to me to be the more likely scenario right now.

There is a lot of hysteria going around, and there are those that predicted that REITs would not survive the year. There are only 3-1/2 months left (plus 2 days) to this year, and no REIT has gone under that I follow.

brucedoe

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