Bonds Archives

Thinking of Buying Junk Bonds? Read This First

While it’s true that junk bonds still pay more than most, the fact is that bargains on junk bonds are becoming more scarce. With interest rates extremely low, buying junk bonds because of the extra income that you will get from their high yield can be tempting, but before you do, it’s best to know exactly what situation you’re getting into.

When a company has poor credit they issue what they call junk bonds and the yield on these bonds tends to be better than those of other low risk debt such as treasury bonds. In the last few years however, the demand for junk bonds from investors has pushed up their prices and cut back on their yields. (The reason is that bond prices move opposite to their yield.)

While the long-term average is approximately 9.5%, junk bonds recently paid out only 5.8%, a gap between their yield and that of comparable treasuries that’s almost 2 percentage points below average.

What that means, given their low yields, is that a junk bond pullback is possible. In July and August of this year it actually happened for about two weeks when, due to worries about the Middle East and Ukraine, US stocks retreated. Since junk bonds tend to move along with stocks, they also pulled back. Even one of the best benchmarks for junk bonds, Bank of America Merrill Lynch US High Yield Master II index junk bonds, declined 1%.

Thankfully the damage caused was minimal, stocks recovered and the US High Yield Master II index has since returned to 5.3%. Unfortunately, that also means that junk bonds are still relatively expensive. According to Mark Freeman, the co-manager of the Westwood Income Opportunity fund, “there hasn’t been a dramatic repricing,” in junk bonds.

That being said, holding on to some junk bonds still makes sense because of their higher interest payments, but financial advisors are still being cautious. Junk bonds could still be damaged if the economy begins to falter or a drop in share prices of 10% to 20%, a stock market correction, happens.

Most financial advisors still recommend keeping approximately 3 to 8% of your portfolio in junk bonds. 2 of the best choices available right now include;

  • Osterweis Strategic Income Fund (OSTIX).
  • Vanguard High-Yield Corporate (VWEHX).

Point being, while dumping your junk bonds completely isn’t necessary, picking and choosing them correctly is a must.

In today’s blog would like to briefly look at Corporate Bonds and High Yield Bonds, what they are and the basics of investing with them. For anyone interested in investing in corporate bonds, this should be some good information to get you started. Enjoy.

 

What are Corporate Bonds exactly?

Corporate bonds, which are also known as simply corporates, are in effect a debt obligation that is issued by either a private or public corporation. You can think of them like an IOU issued by a company. In most cases corporate bonds are issued in either multiples of $1000 or $5000, and the funds that companies raise when they sell bonds to the public are used for a wide variety of different purposes. In most cases the funds are used to expand the business somehow, from building larger facilities to purchasing new equipment and so forth.

When an investor purchases a bond, they are basically lending money to the company or organization that issued the bond and, in return, that company or organization promises to pay that money back (the principle) on a specific date (the maturity date).

Until the maturity date arrives, the company will also pay the investor a specific rate of interest, and usually pay it semiannually. Two very important things to note when you consider investing in bonds is that;

1) Any interest that you receive from your corporate bonds is taxable.

2) Unlike investing in stocks, you do not have an ownership interest in the company or corporation when you purchase bonds.

 

High Yield Bonds

When it comes to issuing corporate bonds, there are a number of credit rating agencies that rate the companies and organizations who wish to do so. Those include Moody’s Investors Service, Standard & Poor’s Ratings Services and Fitch Ratings.

When these credit rating agencies rate companies and find them to be excellent, they qualify for what’s called an “investment-grade” rating. That’s a good thing because it means that the chance the company will default and not pay back the bondholders is very low.

On the other hand, if a company doesn’t qualify for an investment-grade rating (because they have a higher chance of default) these companies are forced to pay a higher interest rate in order to attract investors. The higher interest rate compensates investors for the fact that they are taking on more risk by purchasing their bonds.

You’ll find many organizations issuing high-yield bonds, even US corporations, banks and oftentimes foreign governments as well.

Be sure to come back soon as we’ll be featuring more information about Corporate Bonds in a future blog articles.

What are the Benefits of Investing in Bonds?

Today in the United States investors have a variety of choices in the bond market, including US government bonds, asset-backed securities bonds, high-grade corporate bonds, municipal bonds and also high-yield bonds. But what are the benefits of investing in bonds? In today’s blog we’ll take a look at exactly that. Enjoy.

First, an investor can enhance their current income with high-yield bonds. This is especially true when interest rates are on the decline. Astute investors will focus on the difference between the yields on, for example, high-yield bonds as well as the yields on US treasuries. This is called a “yield spread” and, during almost all of the 1980s and 1990s, the yield spread was between 300 and 400 basis points (i.e. 3% to 4%) for securities that had a comparable maturity. There is an increased risk however, so you need to be willing to accept the trade-off for higher yields.

Bonds give you capital appreciation potential. Things like upgrades, improved earnings reports, a company merges or gets acquired or they have positive product developments can reward the investor with an increase in their high-yield bond’s price.

Security is also an added benefit of investing in bonds. For example, if a company is liquidated, bondholders are more likely to get a payment than stockholders because they have priority in the capital structure of the company. In fact, even an investor who holds a low rated bond will get their share of company assets before both preferred and common stockholders. The reason is simple; during the bankruptcy distribution of corporate assets, holders of  “secured debt” and “unsecured senior debt” will have the highest claim on a corporate assets left over.

Diversification is one of the major tenets of investing and, with high-yield bonds, investors get what’s considered a separate asset class, one that has different characteristics from other securities. Investing in high-yield bonds allows investors to spread their assets across many different segments of the financial market, which reduces their “risk concentration”,  i.e. the amount of risk they take by putting too much of their money into one asset class in their portfolio.

Lastly, high-yield bonds usually have a very attractive “total return performance”, meaning they pay better dividends. This is especially true when the economy is booming and interest rates are either standing level or in decline. Total return performance includes any price changes that occur as well as the income an investor makes from reinvested interest.

As you can see, the benefits that investing in bonds gives an investor are various and, in most cases, potent. If you have any questions or need any advice about investing in bonds, or about personal finance in general, please let us know by leaving a comment or dropping us an email.

Bond Basics: How Bonds Work

Whenever you drive down one of America’s highways, or see a factory expanding in the city where you live, you’re seeing bonds in action. The fact is, bonds are used by both the federal government as well as local and state governments, and private enterprise, to generate the funds they need for expansion, development and long-term infrastructure projects.

What most people don’t realize is that the bond market in the United States is even bigger than the stock market, and that it plays a huge role in the global economy as well as in the lives of practically every American. For example, while the NYSE, NASDAQ and AMEX stock markets have an average trading volume of around $110 billion, the US Bond Market has average trading volume of almost $850 billion.

When you see a bridge being built, you can bet that bonds are what paid for it. New transportation systems that move us around, power plants that give us electricity and sewer systems that bring water to our homes and take waste away are all financed with bonds. In fact, if it wasn’t for bonds, many of the systems and infrastructure that we all take for granted would eventually break down and fall into disrepair.

So, how do Bonds work, exactly?

Bonds start when a government entity or private enterprise issues a bond in order to raise money. They are the borrower and make a legally bound promise to repay the amount of money that they borrow back to the bondholders at a specific time in the future. The amount borrowed is known as the principal or face value of the bond and the payoff date is known as the redemption or maturity date.

The best part however is that the bondholder doesn’t just get their money back, they also get interest, which is known as the coupon rate or coupon, twice a year (in most cases).  In effect, the interest that is paid to the bondholder is the compensation that the government entity or private enterprise is paying in order to borrow the money they paid for their bonds.

Bonds that are issued by the United States government are usually bought directly by the investor but almost all others are purchased indirectly through broker – dealers at either banks or brokerage houses. These are known as the “underwriter” and they act as the intermediary between the issuer of the bond and the buyer/investor.

New bonds are purchased on the primary market and, if someone purchases a bond but wants to sell it before its maturity date, they can sell it on the secondary market.

Over the last few years the pricing of bonds has become much more transparent due to better industry regulation, and investors can see real bond prices on websites like www.investinginbonds.com and others. If you have any questions about purchasing bonds, or selling bonds that you already own, please let us know and we’ll get back to you with info and advice ASAP.

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