Heyer Capital, LLC

investment management and timely advice from a local CPA (Fox Valley, Wisc.)

High Yield Bond Funds

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   One of my first posts on this blog  was a recession investing technique taught to me by a corporate CFO.  (The fact that I was warning investors of recession a year and a half ago ought to make you wonder if little ol’ me in the middle of Wisconsin could figure out the bubble was bursting, why couldn’t the bonus-bloated whiz kids on Wall Street? But I digress.)

   When fear is rampant in the credit markets, you’ll see the difference in yields between theoretically safe Treasuries and the low-rated “junk” bonds expand to more than 1000 basis points, or 10%.  As an example, the 10 year Treasuries might yield 3%, but the junk bond index would yield 13%.  

   Indeed, a Bloomberg article this morning described “armageddon” bond pricing, with the bond market assuming 5% of the corporate bonds outstanding will default, the highest failure rate since the first Great Depression.   That doesn’t mean prices can’t retract further, naturally, but we’re clearly suffering (or prepared to profit from) an enormous level of fear in the bond market.  

   Where to start? Find a bond fund with an indicated average credit quality of “BB” and “High yield” in the fund name.  Look at their latest statement of fund holdings, and have yourself a good chuckle at their hubris. “GMAC”?  “Fannie Mae”?  “Ford”?  Now watch the daily price of that fund. Do nothing, but watch. Is the price in a cascading waterfall?  Is the dividend yield up near 10%? Are more of their holdings defaulting?  Good. 

   Double check your risk fortitude, emotions, and time horizon.  How would you feel if the bond fund fell 20% from these already low levels?    The idea behind this method is to collect a juicy monthly dividend while riding up the price of bonds in a recovery.  You want to get paid well to wait.  You might even consider reinvesting those dividends right back into the fund, but keep good records for the taxman. 

  If your investments are at a no-load fund company itself or a 401k plan, when the time is right, consider starting to average in with price.  Consider making a small investment every week, or twice a week.    If your investments are at a brokerage firm selling high-commission mutual funds (sooooo 20th century) make him work for your business.   Mentally divide your investment into 20 equal sizes.  Tell your broker to make 15 investments over the next six months after your say “Go,” and he gets to pick 5 days to make a double-portion investment on days when the bond market is under extreme duress.  If he doesn’t know what that looks like, well…., enough said.     

   The concept is that this a one or two year investment horizon.  Watch from the sidelines as bonds default & miss interest payments and otherwise go to heck in a hand basket, buy-in gradually, collect the monthly dividends as the price of the fund improves as confidence returns to the bond market.  That is the best case scenario.


Written by heyercapital

October 17, 2008 at 10:56 am

Posted in stock ideas

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