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Earn returns that stock investors would drool over right now, at the top of the capital structure



March 04, 2009 – Comments (8)


I have been extolling the virtues of investing in corporate bonds lately.  Apparently, I am not alone.  I just finished reading an outstanding interview with PIMCO's Mohamed El-Erian at lunch.  The final section of the piece echoes exactly what I have been saying for the past several months:

"You don't anticipate a sharp economic recovery, do you?

No. I see a saucer-shaped one. We've been driving at or slightly above the speed limit through the use of debt. I think the speed limit is going to come down on us so that the potential growth of the economy is going to go from 3% a year to 2% a year over time.

And so you don't see a robust stock market around the corner?

Correct. Lately, one of the smart trades that certain pension funds have been making is selling part of their exposure to stocks and buying high-quality corporate bonds at 8%, 10%, 12% yields. They're saying basically, "I would have been happy with an 8% return on my stocks. Now I can get that amount and be higher up in the capital structure." Remember, if you are in the sectors that are being embraced by the government, you don't want to be in common equity.

Stocks will suffer because investors, just like those pension funds, will say, "Wait a minute. I can buy the stock and have massive risk, hoping to get 8% to 10%. Or I can buy the bonds and still get 8% to 10% from the yield." Yes, you'll give up some of the potential upside of stocks, but the upside hasn't been that great recently."

Bonds provide a much greater degree of safety than common stock does.  This is extremely important to me in today's uncertain economic environment.  I'm not going to sit there with a tremendous pile of cash earning almost no yield in a money market, CD, or Treasury.  I need to get some sort of return on my money.  I have been putting anything that I am able to save into corporate bonds for the past several months.

I can pick up things at the top of the capital ladder at reasonably solid companies that will result in annual returns of 7% to 10% when they are held to maturity.  Even if you think that interest rates are headed a lot higher, you can pick up bonds that are scheduled to mature in only a couple of years and enjoy these yields.  Having bonds of individual companies in one's investment portfolio seems like a no-brainer to me.


Shaking up the Investment Mix

8 Comments – Post Your Own

#1) On March 04, 2009 at 1:10 PM, anchak (99.90) wrote:

El-Erian in front of a WHITE SWAN - nice touch!

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#2) On March 04, 2009 at 2:56 PM, jamasony2 (< 20) wrote:

How does one purchase such bonds?  Through a regular online stock broker, or directly from the company itself?

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#3) On March 04, 2009 at 3:42 PM, TMFDeej (97.73) wrote:

Hi jamasony2.  I personally purchase bonds through Schwab.  I don't think that it is the best broker in the world, but it is a major brokerage that is not in danger of blowing up (as far as I know, HA) so does the trick and I don't feel like switching. 

One good thing about Schwab is that a few years ago it made its pricing on bonds much more transparent.  It used to scalp investors with huge fees that it did not even bother to break out.  Now everything is very, very clear and well laid out for investors.  Its bond commissions are around $10.  You can buy most corporate bonds in $1,000 increments.  Of course, the smaller the increment you buy in, the higher the commission is on a percentage basis.  Still, a $10 commission on a $1,000 investment is only 1%, which is nothing if you hold on to the bond for a number of years.


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#4) On March 04, 2009 at 8:15 PM, EverydayInvestor (< 20) wrote:

OMG he's got a huge caterpillar on his upper lip! I would never trust such a man and neither should you.

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#5) On March 04, 2009 at 8:19 PM, EggplantWizard (51.88) wrote:

One concern I have with bonds is the potential for significant inflation to erode the value of the yield. I'm sure the return would still be very good, especially when averaged over time, but when you buy a bond, you're getting a fixed payment and yield for the life of your holding (with some gain at maturity if the company doesn't default if you're buying below face value). I'm not sold on a hyperinflationary scenario, but I consider inflation upwards of 20% per year more than likely, and locking a 12% rate in seems a little bit premature -- what kind of bond yields would I be able to get in that kind of inflationary environment?

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#6) On March 04, 2009 at 11:29 PM, jamasony2 (< 20) wrote:

Thanks Deej for the info, I'll look into Schwab.

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#7) On March 05, 2009 at 6:19 AM, TMFDeej (97.73) wrote:

Hi Wiz.  I agree with you that it is very possible that a high rate of inflation will happen in the future.  For now I am in the camp that we are in a deflationary environment and that interest rates will remain low for longer than most people think.  I certainly don't expect the Fed to start to raise the Funds rate until the end of 2010 at the very earliest.

If interest rates do begin to rise that may mean that the economy is improving, in which case the massive spread between corporate bonds and Treasuries that we are now seeing will come in some and alleviate some of the pain.

The question is whether the U.S. has to issue so much debt that the foreigners that are now buying more than half of it begin to lose their appetite for it.  That certainly has not happened yet, but it's definitely something to keep an eye on.

The fear of massive inflation in the future is why I have stuck to issues that have less than ten years remaining on them, sometines much less, for the most part.  For now I will rake in outstanding yields.  If rates begin to rise...great I'll just plow the interest that I am getting from my current bonds into ones that pay even higher interest rates.  And when my laddered holdings begin to mature over the next decade I'll just throw the money into even more attractive issues.


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#8) On March 06, 2009 at 2:39 PM, OleDrippy (< 20) wrote:

A huge bond fund company CEO touting bonds? Wierd...

Not that I disagree with him, but we need to remember all these clowns are selling something.

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