The Corporate Bond Wars: Diversification

Larry Denham believes that when it comes to Diversification, Bond Funds win hands down.

Bond Funds: Because the underlying portfolio of most bond funds includes many different types of bonds of various maturities, investing in a bond fund conveniently provides the investor with immediate and widespread diversification. With numerous different bonds represented in the fund, the investor’s exposure to the default /credit risk of any one issuer is minimized.

Individual Bonds: In Larry’s opinion, in order to achieve adequate diversification with the purchase of individual bonds, investors need about $100,000 or more invested in bonds of approximately 15 different issuers. The impact of a default will be greater within a portfolio of individual bonds than with a bond fund, because of the numerous and diverse holdings within a bond fund. When buying individual bonds, default /credit risk in most cases is addressed by limiting investment to essential purpose, high quality investment grade (preferably “A” or better) bonds.

In my opinion, I prefer the “B” or better rated bonds and sacrifice some safety in diversity. I believe that the expectable losses in issues going into bankruptcy over time will still give better returns than bond funds.

An Introduction: The Corporate Bond Wars

Larry Denham, senior vice president and business development officer for Zions Bank wrote a good article called, “Bond Funds vs. Individual Bonds.”, published May 25, 2011. In that article, he made the argument that buying individual bonds is better than buying bond funds. Larry said, “That being said, with the availability of online investing, and after evaluating their circumstances and investment objectives, investors are learning how easy it is to take advantage of some of the benefits of buying individual bonds. Hence, without much publicity, it appears to this author that the argument has quietly shifted in favor of investing in individual bonds.”

It has been my experience from 1980 until now that the brokerage firms have been directing investors toward bond funds. Anyone insisted in investing their money in individual bonds was shown bonds with no or low yields or CCC rated junk bonds. In my case, my broker would not show me any bonds higher than CCC saying that they were not available or that he was not allowed to show them to me. If I was not a bond investor in the 1970s, I may have fallen for that line. Fortunately, around 2004, online brokerage firms with massive bond inventories became available to individual small investors. It was not long after that when I stop walking into full brokerage firm door. I probably will never walk in again.

In order to understand why individual bonds is better than bond funds, it is important to first understand both sides of the bond funds versus individual bonds argument. Most financial authors writing on the subject have focused on the following investment traits: (1) Diversification ; (2) Reinvestment of income; (3) Investment Control; (4) Cost; (5) Interest rate risk; (6) Liquidity; (7) Portfolio size.

In the next future blogs we will explorer these individual traits.

Easy Money for Young IRA Investors

If I had 21 years to go to retirement, I would invest in Pulte Group, Inc. 7.875% of 06/15/2032 bonds. It is a Moody’s B1 and a Standard and Poor’s BB- rated bond. As of May 12, 2011, the bond sold for $937.50 with a Yield to Maturity of 8.517%.

This means if you bought the bond on June 15, 2011 and held it to maturity, you would get $78.75 per year for 21 years or $1,653.75. Plus the investor gets $62.50 in appreciation. For an investment of $937.50 over 21 years, you get $1,716.25 or a total of 183.07%. Since this is in your IRA, your taxes are deferred until retirement. So you can reinvest all the money into other bonds giving high yields. All the company has to do is stay out of bankruptcy and the investor gets their money.

PulteGroup, Inc. (NYSE: PHM) based in Bloomfield Hills, Mich., is America's premier home building company with operations in 60 markets and 28 states. According to Pulte Group Inc., the Company has an unmatched capacity to meet the needs of all buyer segments through its brand portfolio that includes Pulte Homes, Centex Homes and Del Webb. If you are an investor and need additional assistance, please use the internet; contact your broker or Pulte Group’s Investor Relations / Media Relations team.

http://phx.corporate-ir.net/phoenix.zhtml?c=147717&p=irol-contact
You can look up the Public Relations contacts by using the above link.

Investing in the Venezuela Republic

In my IRA, I hold a large position in Venezuelan Republic bonds. Venezuela is an OPEC oil producing country in Northern South America. It is run by a dictator that United States does not like. So the nation’s bonds are given speculative grade (High Yield or “Junk”) by Moody’s and “Standard and Poor’s (S&P).” I buy these bonds that have earlier maturity dates because I am an old man. I want to live to use the money. But for people in their 30s or early 40s, they should look at this bond for IRA purchases.

Venezuela Republic 9.375% of January 13, 2034

It is rated by Moody’s at B2 and S&P at BB-. Ratings have increased in the past 10 years. It pays twice a year, January 13 and July 13 until January 13, 2034. As of this writing, the bond is not on “Credit Watch.” The recent price of the bond is $702.50, yielding 13.642%.

http://deutscheboerse.sh02.de/EN/index.aspx?pageID=108&ISIN=US922646BL74
Look at the bond on the Börse Frankfurt Exchange

That means that if the bond was purchased on July 13, 2011 and kept to maturity, this is what you, the investor would get. On January 13, 2034, you get $1,000 ($1,000 minus $702.50) is an appreciation profit of $297.50. Over the next 22.5 years, you would get $93.75 per year or $2,109.38. In total, the investor makes $2,811.88 per $702.50 bond investment. The investor makes 4 times their money in 22.5 years.

http://data.cbonds.info/emissions/1645/Prospectus_Venezuela_2034.pdf

Prospectus Supplement to Prospectus Dated January 7, 2004