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No. of Recommendations: 3
Now, let's mix things up a bit and buy some junk (aka, spec-grade bonds).

Triple-BBB corporates --especially the lower tier-- are junk disguised as investment-grade. If you're slumming in this trance, you'd better be "diversifying" as widely as you can, and I wouldn't attempt buying with small money. It's just not worth the risk/effort when you're not going to do better than what a well-managed bond fund will do for you. But consider the double-BB tranche. Not many bonds fall into this category. They've been shorn of their tarnished, invest-grade halo --hence, lost an undeserved price prem-- but their fundamentals aren't so bad that default is a huge worry. (It's real, but it isn't more likely than not, as is clearly the case with double-CCs and lower.)

So, here's where things can get interesting. Typically, all spec-grade bonds trade at a discount to par and tend to be fairly near-term. So fundamentals can be forecast with fairly reasonable accuracy, as can default-rates. Therefore, managing your risks with this tranche lends itself to being gamed. "If YTMs are such-and such, how many positions can I lose before I would have been better not buying in this tranche at all?" (In short, you're treating the bond as put and its price is your prem. Pair a low prem with a high return, do it often enough, and you're making decent money.)

Let's say that a tolerable loss-number --when positions are equally-sized-- is one in five. Thus, if you own 15 positions, you can expect to lose 3 of them. You just don't know which three, or when? Let's return to our tiny starting bond portfolio and its tiny $10k funding. You like the returns that investing in spec-grade debt could offer. But you also understand probability well enough that if you put on five positions --at 2 bonds each to keep the position marketable-- you run the chance of losing all five of them, because 'average expectations' cannot be applied to small samples. (E.g., it's possible to get two "100-year" floods back to back and then none for the next 198 years.) Same-same with bond default-rates. Across a portfolio of 100 spec-grade positions, the expectation of losing just one in five might be what is experienced.

Now, here's the problem. In two decades plus of doing this stuff, I have never seen a time when you could waltz into the bond market a pick up 100 double-BBs. So, even if you had the money, you couldn't put it to work. But our starter bond portfolio doesn't have big money. Also, it can't afford to lose a big chunk of it. Thus, realistically, in order to manage risks responsibly, only a single spec-grade issue at a time could be bought, but with this understanding. Over time --i.e., diachronically-- serial diversification can be obtained, just by continuing to buy in that tranche until the sample becomes large enough that 'average expectations' can be applied retrospectively in a meaningful, responsible manner.

(to be con't, because I want to talk about bond funds.)
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