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The “Amazin’s.” For those not old enough to remember, this was the title bestowed upon the original New York Mets baseball team by its first manager, the venerable and eccentric Casey Stengel.
Piloting a team famous for its “amazin’” ineptitude, Casey, nicknamed “The Old Perfessor” would often deride his players by wondering aloud, “Can’t anybody play this here game?”
Unfortunately, this phrase is increasingly brought to mind when we contemplate the mindset of pundits who are purportedly experts in the field of fixed-income investing.
The most recent bit of confounding wisdom was doled out in a Barron’s article “The Great Bond Conundrum” in its April 14, 2012, edition.
The premise of the piece – that higher yields are more difficult to obtain in the current, low-interest rate environment – is indisputable. The subsequent analysis, however, is highly problematic.
The author states that many financial advisors agree that turning to long-term bonds for more yield may be worse than facing today’s “paltry” fixed-income yields.
He cites one such advisor who suggests that investors shorten their maturities and reduce credit quality. This advisor then repeats the common refrain that rising rates would reduce the value of long-term bonds, and although the Fed has committed to keeping rates low through 2014, they nevertheless have nowhere to go but up.
An important omission, however, is the fact that the Fed cannot control long-term rates. There also is no mention of the return to be earned on these short-term bonds, or the consequences if rates don’t go up. It’s important to keep in mind that economists have been predicting a spike in interest rates for the past 10 years.
A second advisor espousing a similar theme recommends Ford Motor bonds, rated BB+, maturing in June of this year, yielding 1.15%.
By the most conservative measures, inflation is running at a rate of approximately 2.00%, making it difficult for us to determine how this advice can even be contemplated. And if that isn’t confusing enough, he covers both sides of his coin by cautioning that these lower quality junk bonds tend to also rise and fall with stock market performance, since both depend on strong economic growth.
In other words, assume the additional risk of lower quality as well as the possibility of meager economic growth, while getting a negative real return on your investment! Doesn’t seem all that enticing to a fixed-income investor.
The author brings in a third expert, a wealth management director for a major Wall Street brokerage. He proffers that buying callable bonds is another “shrewd way to eke out additional yield.” He mentions that corporate bonds maturing in 10 years – but callable in four – currently yield 2.00%. The longer duration risk is not a big concern, he says, because healthy bond issuers are likely to repurchase the bonds at their four-year call date.
But any sophisticated bond investor would ask, why would an issuer retire lower interest-rate debt if rates were sharply higher, as advisors expect?
He then ventures into the municipal bond arena by recommending “Private Activity” muni bonds, which he says yield considerably more than straight tax-free munis. What he doesn’t mention is the reason: Private activity bonds are subject to the Alternative Minimum Tax (AMT), which reduces the after-tax yield dramatically for an AMT taxpayer.
What’s missing from these analyses is a clear-headed knowledge of the fundamentals of fixed-income investing.
Bonds are not stocks. They are purchased for income. Never sacrifice quality to reach for additional yield.
When you are confident about the security of the bonds, maximize your income. If you are investing funds that you will require in the near future, you are in the wrong market.
Over the life of your long-term bonds, sometimes they will be worth more than you paid for them and sometimes less. Income investors rarely sell their bonds.
Understanding the game
We respect a journalist’s need to come up with material and a pundit’s desire to pontificate. We recognize the staid nature of muni bonds and the challenge the market poses for those who need an exciting spin on an investment that, for the most part, simply provides a dependable, steady stream of income to investors.
This does not, however, excuse those who obscure the simple, successful and time-tested precepts of sound investing. Their logic, or lack of it, is simply “amazin’.”
This report is produced solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. This report is based on information obtained from sources believed to be reliable but no independent verification has been made, nor is its accuracy or completeness guaranteed.