Investing In Corporate Bonds and Debentures Is a Bit Tricky At the Moment

I spent a big percentage of my day reading indenture documents for corporate debt securities because I was helping someone pick up some additional fixed income investments for a retirement portfolio.  I managed to get my hands on a nice block of high-grade, non-callable debentures from a major packaged foods company with a 4.3% yield-to-maturity on the remaining decade before maturity, but still have a bit of their dry powder left to spend.  I’m not finding anything on the inventory of my primary broker that interests me.  I thought one of the telephone companies looked like a good risk/reward trade-off but nixed it after going through the disclosures.  The terms of the debt agreement leave me uncomfortable.  I doubt we’ll go into another Great Depression, but if we were, I want them to be further up the capitalization chain.

The strongest AAA securities in the field are yielding around 3.00% per annum, which isn’t terrible if you plan on holding them to maturity and consider them insurance against the world going to hell in a hand basket.  (This is not a time to earn real returns on bonds; the numbers simply can’t achieve it unless you take on far too much risk.  The best you can hope for is to maintain your spending ability.)  If parked in tax-advantaged accounts, you might have a decent shot at keeping pace with inflation, though there are no guarantees.  That’s a fair shake, all things considered.  You certainly wouldn’t want to dive head first into the bond bubble and start locking up rates 30-years out at these prices.  All roads down that path seem to lead to real destruction in purchasing power, though the day of reckoning might not come for a long time.  In fact, 10 years out is as far as I find myself willing to go, unless I were overseeing some sort of financial institution that needed to engage in an asset/liability matching strategy on the duration side.

One thing I find interesting, even though it is entirely irrational: I enjoy the idea of collecting interest checks from gilt-edged railroad bonds.  It seems terribly romantic to me, no doubt a by-product of years of reading old textbooks by Benjamin Graham and other Depression-era thinkers who considered safety of the income stream on fixed income securities as the primary concern of a conservative investor.  In a day when railroads were the bluest of the blue chips, these debts were the standard against which all other assets were held.  (I watched an old movie on Netflix last year in which the family of a rich woman were scandalized to learn that a man in their home owned lowly, dirty common stocks instead of bonds.  It was funny to see them so offended, as that really was the attitude of a large part of the population.)

I long for the day of modest inflation, 3% to 4% dividend yields, and 7% to 8% 10-year corporate bond yields.  A lot of retirees (and insurance companies, for that matter) are lucky in the sense that they are locked into much higher coupons from days now in the distant horizon.  If you retired in the mid 1990’s and decided to put 25% of your portfolio in 30 year, good, non-callable corporate bonds, you’ve still got a decade of fairly high yields to enjoy before maturity arrives.  Considering the risk and effort required, both of which are very low (present known factors considered), they have treated you very well.  The money showed up like clockwork, along with your Social Security or pension checks.  Though it may have seemed overcautious, Graham’s prescription performs extremely well through almost all 25-year holding periods.  Ibboton & Associates did some very interesting quantitative studies on the effect of even a 10% bond allocation over longer holding periods; it drastically reduces overall volatility, while barely lowering returns.  The more academically minded among you will love it, so add it to your reading list.

On the upside, the bond bubble seems to be deflating itself slowly as maturities come up, which is the best possible outcome society can hope to achieve.  Ideally, 90% of the investment population will have no idea how bad it could have been had a sudden spike in interest rates resulted as a by-product of a major economic shock.  There’s a lot to be said for “dumb” portfolio management.  A retiree with a bank vault full of corporate bonds, municipal bonds, savings bonds, and even certificates of deposit wouldn’t have noticed the madness at all if he or she focused solely on the interest checks that arrived in the mail or were credited to their principal balance.

I’m keeping my eye out for any sort of clever exploit I can use, like some highly illiquid, convertible debt securities, but nothing is pinging at the moment; at least not with the margin of safety I want.  I’m also going through the municipal bond offerings for Missouri, but nothing seems to be worth it to me at the moment based on the safety trade-off and tax rates of the investor I’m helping.