Bond investing --as opposed to bond trading -- is nothing more than comparative shopping. “How much reward am I being offered for accepting how much risk?” So let’s go shopping in the offering-lists. No matter your broker, if they offer online access to bonds, they likely offer a search-engine, some of which are easier to use than others. (E*Trade and Zions Direct get good marks. Scottrade and TD AmeriTrade not so much, with Fidelity, Schwab, and Vanguard falling somewhere in the middle.) According to the parameters you select, you’ll be returned a list of currently-offered bonds that could number in the thousands. So narrowing your search is a necessity, and --following Ben Graham’s guidelines-- you’re are likely to be one of three types of investors : ‘Defensive’, ‘Enterprising’, ‘Speculative’. Those three can be mapped onto the 22, bond-rating notches as follows: Defensive Investors will target bonds rated no lower than single-A by any of the three agencies (or the market itself).Enterprising Investors will target bonds rated lower than single-A by any agencies (or the market itself), but no lower than double-BB.Speculative Investors will target bonds rated by any of the agencies (or the market itself) single-B or lower. Thus, if your intentions are “defensive” bond-investing (in Ben Graham’s sense of that term), you will filter from consideration any bond that isn’t rated AAA, or AA, or A. If your intentions are “enterprising” (in his sense of the term), then your target is the set of bonds rated BBB to BB, but no lower. If your intentions are “speculative”, meaning, you’re willing to take on the equity-like risks that stock investors normally do, then your target will be the set of bonds that are single-B or lower. So, let’s summarize our shopping rules: (1) Market-implied ratings trump agencies-assigned ratings. (So learn how to use them.)(2) Any split-rated bond defaults to its lowest rating (assigned or implied). (3) Any unrated-bond (with the exception of bonds such as Agencies that would otherwise carry a triple-AAA rating) is assumed to be spec-grade. So, the shopping task becomes that of finding the best-priced bonds (aka, the least-worst in terms of risks relative to yield) of what is currently offered within your target. In today’s market, if you’re attempting to do defensive bond-investing, you’re going to lose money on an after-taxes, after-inflation basis. So your task is to figure out how to lose it as slowly as possible while you wait for conditions to improve. They will eventually. Meanwhile, your buying amounts to treading water, aka, a cash-management gig. I dislike this part of the bond market. The stuff tends to be over-priced and long-dated. Fortunately, the risks in this tranche tend to be fairly obvious. BK filings are few, and recovery-rates tend to be decent. In today’s market, there aren’t many opportunities available for enterprising bond-investing. But there are some, and I’ll get to them in a future post. This, definitely, is the hardest part of the bond market for investors to deal with, especially the triple-BBBs, because the risks are so subtle and far more extensive and serious than most investors blithely assume. Worse, prices tend to be close to par, but recovery-rates tend to be close to zero. In stretching for yield, it’s very easy to get yourself into trouble in this tranche. If your intentions are speculative bond- investing, then you’re in luck. Prices aren’t as good as they were coming off the 2009 bottom, but there’s plenty of sectors and industries to look at. Prices are still low enough to be attractive. Maturities tend to be nearby, and singles are generally available. For very little money, it isn’t hard to put together a basket of speculative bonds that can achieve investment-gains that are competitive with those of the best fund managers. It short, this is my favorite part of the bond-market. The work isn’t hard, and the money can range from ‘decent’ to ‘spectacular”, as in, some single-position gains will be in excess of 100%. Not often, but the right-hand tail is fatter than most fixed-income investors realize, as study after study documents. […to be continued]
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