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