Incorporating Bonds Into Your Portfolio
The Dynamic Wealth Report
January 16, 2009
Follow The Money - Where To Put $882 Million
I’m 10 years old and sitting at the kitchen table with my
grandfather. I remember it like it was yesterday. He was reading the
paper and I kept asking him questions about the stock market. I must
have been on my 3,000th question when he told me something shocking. At
least to my 10 year old brain…
You could loan money to people, and they’d give you more money back.
It was a very simple concept, learning about interest. But I was blown
away at the time. My mind raced with thoughts of making lots of money.
That’s how my first introduction to bond investing went. Loan out money,
get more money back.
Over the years I’ve learned a great deal about investing from my
grandfather. He’s explained stocks, bonds, commodities, even real
estate. I remember the discussion about bonds most clearly.
Right now many high-yield bond investors are feeling the same way I felt
then... excited and happy!
Last week, High Yield Corporate Bond funds received the largest inflow
of cash in many years - $882 million in all. This is on top of the $690
million and $731 million invested during the last two weeks of December.
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That’s a lot of money being put to work.
Why are investor dollars flowing into these funds at such a high rate?
Before we get to that… let me tell you a little bit about high yield
bonds.
High yield bonds are bonds with a great PR (public relations) firm. You
may know these bonds by their less flattering name – Junk Bonds.
High yield or junk bonds are typically issued by companies with a credit
rating below “BB.” Their stated interest rates are usually three or four
percentage points higher than those of government bonds. Why the higher
rate?
Because they have a higher risk of default.
Most high yield bonds are issued for one of two reasons - general
corporate purposes or to fund an acquisition. In the 1980s the junk bond
industry became famous for financing the leveraged buyout boom. Today
the high yield industry has issued more than $600 billion in bonds and
has offerings from nearly every industry.
So what’s so special about these bonds? Why is all this money flowing
into high yield bond funds now?
I’ve got one word for you – YIELD.
Right now a 10-year U.S. Treasury Note (T-Note) is yielding about 2.3%.
High yield bonds normally provide 4 or 5 percentage points of yield over
T-Notes. That’s known as the spread. Today the Merrill Lynch High Yield
100 has a yield of more than 12%, a spread of more than 10 percentage
points over T-Notes.
That’s more than double the normal spread.
But that’s nothing. Earlier this year the yield was over 17% - that’s a
spread of almost 15%.
The spread’s a great indicator of fear. The bigger the spread, the
bigger the fear companies will be going bankrupt. Clearly the market was
very, very fearful when yields were 17%. Now yields are falling and the
spread is tightening… a good sign the markets are returning to normal.
The opportunity to grab part of these big yields is quickly slipping
away. As investors on the sideline become disgruntled with government
bonds only paying 2%, it won’t be long before they’re looking for
something with a better return.
Now there is a risk. Some of these companies could go bankrupt rendering
their bonds worthless. Investors might lose a chunk of their hard earned
money… to some that’s a risk worth taking.
If you want to buy into these funds you might look at a high yield bond
mutual fund. According to Morningstar there are more than 150 to
choose from. I know Vanguard has the High-Yield Corporate Fund (VWEHX),
or you might look at the Fidelity Capital & Income Fund (FAGIX).
There’s an ETF you can trade as well.
One I like is the iShares iBoxx High Yield Corporate Bond (HYG). It
boasts heavy trading volume and a 12% yield. With assets just under $1
billion, they’re not as big as the mutual funds, but big enough to
provide some decent diversification.
Take a close look if you want to add a high yielder to your portfolio.
Editors Note: Monday the financial markets are
closed in celebration of Martin Luther King Jr. Day. We hope
everyone has a great three day weekend. We’ll see you again on
Wednesday with another Dynamic Wealth Report.
• Boston Properties (BXP) was upgraded to an
“Overweight” at JP Morgan. The REIT is down more than 50% in the last 4
months. It looks like the real estate crunch is starting to impact
commercial property as well.
• Suntech Power (STP) was downgraded by both Friedman
Billings and AmTech Research. The company cut estimates back in November…
it looks like analysts are expecting even worse numbers.
• Collins Stewart started research coverage on Amazon.com
(AMZN) with a “BUY” rating. That makes 22 analysts covering the stock. Anyone ever hear the word overkill?
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