BradentonHerald.com - November 18, 2008
The ongoing credit and liquidity crisis has caused dislocation and fear in the corporate and municipal bond markets, resulting in losses like one would normally expect from stocks during a severe correction.
Many top corporate bond funds, which, as little as a year ago, were being lauded as wonderful investments are now down in the 20–30 percent range.
Does this mean these funds are not good investments any longer? No one knows how the next several months will go, but for investors looking to position their portfolios to take advantage of the ultimate recovery from the current economic situation, there may be some great opportunity in the area of corporate and municipal bonds.
Normally, municipal bonds issued by city, county or state governments provide a lower yield than comparable U.S. Treasury bonds due to their tax-free status.
Presently, 10-year Triple A rated municipal bonds are yielding about 4.25 percent tax free, while 10-year U.S. Treasury Bonds yield only 3.75 percent, which represents a 2.70 percent after-tax yield to an investor in the 28 percent tax bracket.
After accounting for taxes, you earn an extra 1.5 percent annually on a secure investment.
This opportunity has been at least partially created by forced selling of municipal bonds by hedge funds that are facing redemptions by investors and margin calls on the funds they borrowed to invest.
Corporate bonds are classified in two basic groups. High quality bonds, those rated A, AA, or AAA by rating agencies, are issued by companies with a very stable financial status and the bonds are usually secured by assets of the corporation.
These higher quality bonds tend to pay smaller yields, normally 1–2 percent, above the rate offered by U.S. T-bonds to compensate for the fact that no corporation can be as secure as the government of the United States.
High-yield corporate bonds are issued by companies with lower credit ratings, and investors demand additional compensation in the form of higher interest yield, to purchase these riskier bonds.
Typically the spread in interest rates for high yield bonds is 4–6 percent above the U.S Treasury bond yield.
Today’s credit crisis has spread fear of default to the point where high quality corporate bonds are yielding about 4-6 percent more than T-bonds, and high-yield corporate bonds are at an astounding 16 percent spread over treasuries. Even if you assume default rates double or triple the norm, or even as bad as the defaults observed during the Great Depression, you should still earn a higher total return over the next several years by owning both high quality and high-yield corporate bonds, compared to buying a 10-year Treasury bond yielding about 3.75 percent.
For those with some patience and the ability to put up with some fluctuation in principal value, these trying times have created what I believe are some great opportunities to earn above average returns on corporate and municipal bonds over the next several years.
Tom Breiter, the president of Breiter Capital Management, Inc., is a registered investment adviser. He can be reached at (941) 778-1900 or by e-mail at: tom@breitercapital.com.
