The Guru Strategy For Bond Investing

 

warren buffett bashes bondsThe guru strategy is simple.

1) Pick a really smart investor, like Warren Buffet or David Einhorn.
2)  Find out what securities they are holding.
3) Buy them.

For stock investors, there are sites that make this process very easy like Guru Focus. For bonds however, the process is more complicated:

1) Find the mutual fund that you want to copy on Morningstar.
2) Click on the “Holdings” link which is under the Portfolio Tab.
3) This will give you name of issuer, the coupon rate and the maturity.

To find the bond’s CUSIP number which will enable you to have your broker to buy the bond, you will need to plug this information into FINRA Trace system.

 

To see a list of high yielding CDs go here.

 

There are two main benefits of this strategy:

1) You get to follow the investment advice of Warren Buffett or David Einhorn without having to pay a management fee or a premium. For example, Warren Buffett’s company Berkshire Hathaway trades at a P/E ratio of 18, while many of of stocks it holds trade a smaller multiples, like Wells Fargo (10) and IBM (14). In the case of David Einhorn, the fees of his hedge funds are probably 2% of assets and 20% of profits. The guru strategy enables you to use their ideas and save money.

2) The guru strategy gives more investment flexibility. As you will be owning individual securities, you will be able to chose which ones to sell and when.  This compares to investing in the fund where when you buy and sell you are essentially buying and selling the whole basket of securities the fund holds.  This gives you the freedom to time sales according to your tax situation and your personal view of the companies.

Both of these reasons are equally true for bond gurus such as Bill Gross and Jeff Gundlach, as they are for stock gurus like  Warren Buffett and David Einhorn

 

There are two main drawbacks of this strategy.

1) You could be trading on 4 ½  month old information. Mutual funds are required to disclose their holdings every 3 months. However, they have two months after the close of a quarter to report their holdings.  Imagine the case, where a mutual fund entered into a trade two weeks after the reporting period and held the position for only a month. If you chose to buy and sell based on the fund’s disclosure documentation, you could be entering the trade 4 months after the fund and selling it 3 months after the fund closed its position.

To minimize the probability of this happening, we recommend that the funds you follow:

  • Report holdings within two weeks of the end of their quarter
  • Have low portfolio turnover, under 25%.

This information is available about a fund from Morningstar.

2) Purchasing one or several securities of a portfolio can lead to performance which is significantly different than the overall portfolio. Jeff Gundlach’s Doubleline Total Return Fund often buys bonds which have opposite price behavior, which lowers the portfolio’s overall volatility. In other words, you could be buying bonds which the fund is purchasing for “insurance” rather than expressing the portfolio manager’s view as to the market’s direction.

To avoid this, we recommend funds whose manager is tasked with finding the best of a particular type of security, like “High Yield Bonds” or “Convertible Securities”.

The above drawbacks apply equally to stock and bond funds.

 

One More Drawback For Bond Funds

With stocks, individual investors and professionals will receive similar pricing when buying and selling.  However, this is not true with bonds. Its not unusual for a retail investor to pay 1% more than a professional to buy the same security. Unless a fund has a big sales load, this additional cost can eliminate the advantage of not paying management fees.

If you have a strong preference for buying individual bonds instead of funds, looking at what the bond gurus are buying is a great way to get ideas. However, trying to exactly copy the trading activity of particular fund is not possible due to reasons mentioned above.

 

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