No. of Recommendations: 1
Jack writes: I would break it down like this:

A = Above-average-return/low-risk
B = reasonable-return/low-risk, or above-average-return/moderate-risk
C = above-average return/high-risk, or reasonable-return/moderate-risk
(Note: There is no low-return/low-risk; if this is your bond choice, buy a CD and avoid the all the trouble.)

Using the above methodology, we use published ratings as a screening tool and as one analytical metric among many. This means we could find BBB+ companies that are A's on the above scale and AA companies that are B's and A's that are C's.

One disparity that has been constant and that has been mis-pricing; some debt has been too expensive for the quality, some debt has been too cheap for the quality. If we are patient and diligent we can spot these traps and opportunities. It may be easier with all this messiness to spot the good and the bad.


Continuing the previous ideas, I would restate them as follows:

The Four Sources of Credit Ratings Upsides
The Major Rating Agencies free, easily-obtained, authoritative
Bond Boutique Ratings higher quality than the majors
The Bond Market Itself free, easily-obtained, timely, authoritative
Your Own, Traditionally-done CR's free, timely, authoritative


The Four Sources of Credit Ratings Downsides
The Major Rating Agencies often not timely, must be interpreted and/or arbitrated
Bond Boutique Ratings expensive, with limited coverage of issuers
The Bond Market Itself "screen time", spreadsheet skills, intuitive judgment
Your Own, Traditionally-done CR's sustained effort, good financial-statement skills

Thus, a “Catch-22” situation arises. To know whether a bond is being properly priced, you have to know that it is being properly rated. To determine if the bond is being properly rated, you have to know whether it is being properly priced. The two factors are inter-dependent.

An aside: By and large, agency ratings are timely enough and accurate enough for their intended users, which is not retail investors. Once the implications of that phrase sink in, then agency ratings become useful tools, especially when supplemented –as they have to be— with one’s own technically-based and/or fundamentally-based analytic work.

In short, if you would require that agency rating be useful at face value, you probably shouldn’t be buying your own bonds unless you pair your trust of agency ratings with game-theoretic ways to manage the risks you are accepting. What might some of those risk-management techniques be? Ah, grasshopper. That’s a post for another time. But what does emerge is something like the following:

The Projected Reward Relative to its Current Mis-rating/Mis-pricing
Egregiously Higher (and Margin of Safety) Classic, Graham-style Value Investing (long)
Higher of no investment interest
Benchmark (aka, properly proportional) useful only for informational purposes
Lower of no investment interest
Egregiously Lower Classic, Graham-style Value Investing (short)


Incidentally, I executed my 31st bond buy for this year last Friday. The CY for those positions is 9.2%, and their projected YTM is 14.1%. My credit qualities range from AAA to CCC. The coupons range from 0% to 8%. Maturities range from 4 years to 28.

In other words, I build and manage a classic, Graham-style bond portfolio on the basis of the guidelines laid out in his The Intelligent Investor: a Book of Practical Counsel. What Graham advises is what I do, because his low-effort, low-risk methods are as effective with corporate bonds as they are for stocks. It's the same underlying company that is being analyzed, and the same common-sense principles that are being applied to its evaluation.

The method and investing viewpoint that Graham describes is available to anyone who is willing to read his books and to put that viewpoint and method into practice, which academic studies have shown is typically less than 5% of investors. So that's the paradox is value investing. Nothing is more effective, on average and over the long haul, as a means of obtaining reasonable investment returns. But no other method gets more neglect, because value investing requires patience and independent thinking, which are two virtues that most would-be investors lack. So they do whatever the crowd does, because it seems "safer".
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