If you're a stock investor, January felt like the 13th month of 2008. The New Year came in just like the old year went out, as the S&P 500 dropped over 6% -- its worst January on record.
But for investors who dared to venture outside the stock box, January brought some good news. Within long-neglected asset classes, such as the corporate bond market, investors who beat the crowd reaped some healthy rewards.
Bonds aren't boring
For whatever reason, many investors who find stocks fascinating don't give bonds the respect they deserve. Perhaps you think of the $25 savings bond your grandmother gave you when you were a kid instead of the toy you really wanted. Or maybe you immediately look to Treasury bonds, whose low yields right now could put even the most avid income investor to sleep.
But within the larger bond market, opportunities abound. Remember, all the current problems we're facing throughout the economy stem from troubles that originated within the credit markets. The mortgage-backed securities that investors now dub "toxic assets" originally helped banks increase their lending capacity. The trillions in credit default swaps that many now fear could bring the next wave of panic to the financial markets were designed to protect bond investors from default. In the cataclysm investors suffered through in 2008, the bond market was ground zero.
However, after a long period in which bond buyers shunned anything less than ultra-safe Treasuries, interest in corporate bonds has finally reawakened.
Betting on bonds
The first question many investors have when considering bonds is how you go about buying them. Unlike stocks, which are relatively easy to find, research, and buy from a host of different brokerage firms, the market for individual bonds doesn't make things simple for investors. Although you can find some brokers that will help you investigate bonds, you won't get the same level of support you can get with stocks.
That's the reason why many bond investors stick with mutual funds and, more recently, ETFs. A quick glance at a few corporate bond funds shows why more investors are getting interested in the sector lately:
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Fund
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YTD Return
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Current Yield
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Bond Holdings Include:
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Vanguard High-Yield Corporate (VWEHX)
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5.7%
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9.6%
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Freeport McMoRan (NYSE: FCX), Qwest (NYSE:Q)
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Fidelity Investment Grade Bond (FBNDX)
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1.1%
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5.3%
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ConocoPhillips (NYSE: COP)
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|
iBoxx High Yield Corporate(NYSE: HYG)
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6%
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10.6%
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MGM Mirage (NYSE: MGM), L-3 Communications (NYSE: LLL)
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Source: Morningstar. Returns and yields as of Feb. 2.
Particularly in the high-yielding junk bond arena, investor interest is on the rise. The most likely reason? Yields that are high enough to cover investors even if default rates end up being well above historical levels.
Default: not a total loss
If you're used to investing in stocks, you tend to think of business failures as total loss events. Typically, shareholders get completely wiped out in a bankruptcy proceeding.
For bond investors, though, it's much different. If you own bonds in the most senior tranches -- that is, the bonds that are first to get paid -- you'll often get 100% of your investment back. Even if you're further back in line for payouts, you may recover a substantial fraction of what you would have received at maturity on your bonds.
So if you can get a lot higher interest payments, then it may be worth the risk. Even relatively strong businesses like FedEx (NYSE: FDX) had to pay 4.5 percentage points above Treasuries -- and when those spreads narrow, corporate bond investors reap the benefits.
Bank on bonds
How long the recovery in the corporate bond market lasts depends on the economy. If business defaults start to rise dramatically, then it may turn out the high spreads on corporate debt were justified. Barring a complete meltdown, however, corporate bonds may well outperform Treasuries for years to come.
