Last week, I wrote two articles for LearnBonds.com. One discussed the fact that high-yield bond spreads were finally starting to widen at the same time that benchmark Treasury yields were also widening. The other, “One Way to Find Value in Today’s Low-Rate Environment,” discussed the benefit of searching for individual bonds that have experienced above-average spread widening. With those two articles in mind, on Thursday, I went searching for individual corporate bonds that met the following criteria: triple-B to double-B ratings, less than 10 years to maturity, trading below par, and having what I view as enticing yields and moderate credit risk.
Before sharing the results, I would like to answer three questions that I anticipate some readers might have about my search criteria:
- Why did I go all the way out to 10 years to maturity rather than sticking with bonds maturing in the next few years?
I am of the opinion that the Fed will not be raising rates for a very long time. By the time the Fed does eventually raise rates, these bonds will have worked their way down the yield curve (definition of a yield curve – click here) to such an extent that there will be very little risk of significant price declines as a result of short-term benchmark yields rising. The greater risk to price declines would come from credit spreads widening, which is certainly a possibility with any of the soon-to-be-presented notes. Additionally, given the slow economic growth environment I anticipate over the coming years, I think the yields represent attractive rates for a fixed income investor. The bigger question, in my mind, is whether the credit risk is appropriate for each investor. And that is something each of us will need to determine on our own. What is right for my portfolio may not be right for yours, and I certainly encourage readers to do their own due diligence on the companies backing the notes.
- Why not search for single-A or higher rated notes?
Spreads have not widened enough on single-A-rated or higher than single-A-rated notes to find a variety of bonds with attractive yields at those credit ratings. Moreover, benchmark yields have not risen enough to push yields in that part of the credit-rating spectrum into “attractive” levels. It is also true that spreads in the triple-B space have not widened by a significant amount across the board. But there are plenty of specific triple-B issues that have experienced above-average spread widening, creating value that doesn’t exist in other parts of the investment grade corporate bond universe.
- Why stick to bonds trading below par?
By focusing on bonds trading below par, I was able to more easily find some of the issues that have experienced company-specific above-average spread widening. Additionally, by sticking with notes trading below par, I was able to concern myself less with call features than I otherwise would if the bonds were trading above par.
What were the results of my search?
At the end of my search, I had found 12 different companies with individual bonds that fit the bill. I jotted down Thursday’s closing offers for each of the 12 CUSIPs and did the same on Friday. During the day on Friday, there were nearly across-the-board drops in yield for the 12 bonds I identified on Thursday, causing some to trade above par at the end of the week. If Friday’s closing offers and yields pushed any of the notes into non-attractive territory for you, consider watching them closely, as the prices and yields can change quickly, making them more attractive at a moment’s notice.
The table that follows shows each of the companies, CUSIPs, maturities, coupons, Thursday closing offers and yields-to-worst, and Friday closing offers and yields-to-worst. The notes are presented in no particular order.
Four closing points:
- Friday afternoons can be quite illiquid across portions of the individual corporate bond market. It is possible that some of the closing offers (I’m thinking of the Toll Brothers notes in particular) will be adjusted lower early in the day on Monday regardless of movements in benchmark rates.
- Thursday to Friday’s big move lower in some of the yields shows the importance of having an actively managed watch list and reacting to opportunities as soon as they present themselves.
- I think the aforementioned notes are attractive in the context of a diversified individual corporate bond portfolio. But I recognize that some investors may not be able to adequately diversify across a multitude of individual bonds. If you are unable to build a broadly diversified portfolio of individual bonds, then any one of the aforementioned notes may not be suitable for your portfolio. Moreover, your risk tolerance and time horizons may be such as to render any or all of the notes unsuitable for your portfolio.
- There is a Fed meeting this week. Both the Fed’s statement and something said during Bernanke’s scheduled press conference on Wednesday could cause a large move in either direction for benchmark Treasury yields. That, in turn, could cause a large move in either direction for any of the corporate bonds mentioned in this article.