Bond Portfolio

[aiki14]

I spent a lot of time last week involved in putting together a portfolio of Bonds for a relative. Yields went down through the week as money came out of the stock market and into the bond market but I was still able to get $2 million in high grade corporates to average just under 8%. The restrictions on my choices stemmed from this being a retired couple in their mid 70's with no earned income, looking for principal protection first and income second. Overall financial picture made the corporates more favorable than muni's in their specific case, but it was close especially towards the end of the week. They live in NY which is a high tax area, so it was closer than it would have been in lower tax states. I was a bit surprised by this as going in I thought triple free muni's would be the better way to go. I found that the top rated muni's, equivalent to AA+ or AA1 corporates were hard to come by and their rates produced only 6-7% after tax yields. Muni's paying 5% tax free may equal 7% to a person in a middle tax bracket, but I couldn't get the 8% I was getting with the corporates.
I also was looking to get a bunch of bonds whose coupon was paid in each month so they would have a consistent income. All the bonds I ended up with had semiannual coupons (2 per year). I did not use floating or variable coupons because I wanted consistency versus a play on yield risk. In that I do believe we will see a rise in the rates the variables track, if you are considering bonds and you are not in the same situation as this couple, you may want to look at these types of bonds for a couple of extra points going forward.

The companies who issue these bonds were predominantly financial companies, and some blue chips. Their were also some sovereigns which I thought was interesting as I didn't realize they would be in with the corporates.
I went with bonds with long maturities to ensure they would not have to remake the portfolio in any major way for their likely lifetime. Only a few of the bonds mature earlier than 2018 and some go out to 2035.
Most of the bonds are callable at par (100) or make whole call, but I got a few non callables, and none were callable until 2012 except the make whole's. I tried in all cases to get senior notes, but went with some subs in the short maturities to add yield in the first couple of years.

So here are the companies whose bonds I ended up with:

GE Cap Corp, GS, Appalachian Power, JPM, Hydro-Quebec, B of NY Mellon, JNJ, Kfw Frankfurt/Main, and J. Hancock. I know I am forgetting one or two buy I don't have the portfolio in front of me.

Some I didn't use that were rated AAA or aa1 or better were:
Toyota Motor Credit, Household Finance, Countrywide financial, RBC, and Intnl Bank for Recon and Dev.
Frankly I was amazed the Countrywides and HFC's were rated so highly.

If anybody is seriously considering this type of investment and wants more specific info Pm me with any questions or post them in this thread as you prefer. I did not include CUSIP's or name the Specific bonds because in some cases I bought all the offered, and the offers change as they are traded. All the issuers I listed have many issues of the same rating, close maturites, and similar coupon/yield, so if you have a way of screening for bonds you'll certainly see bonds identical or nearly so to the specific ones I used.

[OptionsPlease]

I would like to learn more about bonds I am only 20 and there's a few things I know about them. Municipal Bonds are tax free and consol bonds have no maturity. There is a issue price if you buy the bond from the firm and not from underwriting....Although why would people sell their bonds to others when it has hit maturity. Don't they loose money? Thats all I know........
Yes I know a bond is debt security and not a equity stake in a company like a stock. I know the interest is called a coupon.
(http://en.wikipedia.org/wiki/Consols)

[aiki14]

I would like to learn more about bonds I am only 20 and there's a few things I know about them. Municipal Bonds are tax free and consol bonds have no maturity. There is a issue price if you buy the bond from the firm and not from underwriting....Although why would people sell their bonds to others when it has hit maturity. Don't they loose money? Thats all I know........
Yes I know a bond is debt security and not a equity stake in a company like a stock. I know the interest is called a coupon.
(http://en.wikipedia.org/wiki/Consols)

A couple of things:
Muni bonds are Tax free from federal tax, but may not be from state or local tax. Usually they are tax free from state tax in the state of issue, so if you live in Wisconsin look at their bonds first and how they treat out of state muni's before you buy them.
Once a bond matures it is payed off and no longer trades.
Bonds are issued at Par (usually 100) and then subsequently trade at a discount to Par or a Premium to Par. The coupons never change unless they are variable or floating rate, but the yield changes based on the price the bond is purchased at.

Here are some Bond resources
http://www.investinginbonds.com/
http://www.bondsonline.com/
http://www.morganstanleyindividual.com/markets/bondcenter/school/

To answer your question on Equity Linked Notes
They are really designed for conservative investors with low risk tolerance or certain institutions who's charter limits equity exposure. They can be constructed using a Long Discount Bond Position and a Long Call Option on the same underlying. They use the Discount on the bond position to fund the Call thereby providing 100% principle protection, but if the stock goes down and the call expires worthless all you have left is the Discount Bond (Which is the regular bond with the coupon stripped out). In some cases you can make a small profit on the difference between the discount and the call, or you can get limited upside participation in exchange for a few points of the coupon.

[madcowdisease]

Aiki, it sounds like you did your homework, specifically with regard to the after-tax yield and muni tax equivalent. However, given the bond ratings are you at all concerned about the ratings changing? Afterall, Moodies etc was giving the garbage that caused this mess investment grade ratings before the bottom fell out.

This market environment is one in which 99% of those on Wall St and and "advisers" have never experienced since they are all too young to remember the last epic crash. Are you confident these analysts can accurately forecast what the underlying corporations will experience? I too am very surprised the financials had ratings any higher than Ba given what is transpiring right before our eyes.

I'm not sure if you checked out any municipal revenue bonds with a rate covenant or if you were just scanning the GOs. You should be able to find a higher yield on the revenue bonds.

Lastly, I know you stated this couple was concerned with capital preservation and income. Interest rates are quite low at this moment. I'm not sure how long the Fed will keep them low. I suspect for the next 6 months possibly more. With that being said did you take in to account how future moves in interest, likely higher, will affect the price of these bonds? If this couple plans to hold to maturity then it doesn't appear there will be a problem, except for a negative effect to purchasing power, but if they at any point want to sell the bonds an upward move in rates will knock these bonds down in price -- especially so with the maturities selected (2018-2035).

[aiki14]

Aiki, it sounds like you did your homework, specifically with regard to the after-tax yield and muni tax equivalent. However, given the bond ratings are you at all concerned about the ratings changing? Afterall, Moodies etc was giving the garbage that caused this mess investment grade ratings before the bottom fell out.

This market environment is one in which 99% of those on Wall St and and "advisers" have never experienced since they are all too young to remember the last epic crash. Are you confident these analysts can accurately forecast what the underlying corporations will experience? I too am very surprised the financials had ratings any higher than Ba given what is transpiring right before our eyes.

I'm not sure if you checked out any municipal revenue bonds with a rate covenant or if you were just scanning the GOs. You should be able to find a higher yield on the revenue bonds.

Lastly, I know you stated this couple was concerned with capital preservation and income. Interest rates are quite low at this moment. I'm not sure how long the Fed will keep them low. I suspect for the next 6 months possibly more. With that being said did you take in to account how future moves in interest, likely higher, will affect the price of these bonds? If this couple plans to hold to maturity then it doesn't appear there will be a problem, except for a negative effect to purchasing power, but if they at any point want to sell the bonds an upward move in rates will knock these bonds down in price -- especially so with the maturities selected (2018-2035).

I am always concerned with the ratings and what the ratings mean. I know the ratings on CDS, MBS, and other derivatives were hogwash. But I cannot do the kind of due diligence required to rate a company and it's debt instruments in the kind of time I had, or even if I had unlimited time if I am competent to do such an evaluation. I had to use some criteria, and a combination of Moody's and S&P ratings seemed sensible, as well as noting when the ratings became effective, and if they were on credit watch currently. I also used my own sense of the company as an ongoing concern to guide my choices as well.

I looked at the Muni's but more at the couples tax returns from the last coupe years, they just aren't gonna get the tax benefits of muni's to be meaningful. I looked at the rev's as well, but then I ran into the same thing, as well as only the long maturities having near the yield I needed. Also NY only issued so many bonds and I was trying to get the monthly payments. All these things made Muni's sub optimal.

I agree with your take on interest rates, but the couple was more concerned with locking in a predictable monthly income which in combination with their pensions, SSRI, and the gentleman's military disability pension, would reasonably assure them of both the lifestyle to which they aspire and an inheritance for their children and grandchildren. They also did not want to have to be burdened with trading the bonds over the years as they matured. By the time any of the bonds come to maturity they will probably be ok with using off the principle or using CD's.

Thanks for your advisers eye view on this. I probably would have saved a lot of time by talking to you beforehand.

[shisya]

I heard in a podcast the other day that the rating companies are unregulated and they come under the "freedom of Speech" part of the constitution, where, what they are expressing is just their opinion.

So, you can't really hold them to what they are saying.

[smartinvestor30]

All I can say is it never ceases to amaze me the amount of wealth someone in America in make if they just understand all the financial instruments that are available to them. I was too young in the 80's and 90's to invest in anything I turned 18 in 2002. There were so many options available for people to create wealth and live like a King but I'm sad that those opportunities might not be around anymore when I get to the age where I have a few million to throw around.

[madcowdisease]

I am always concerned with the ratings and what the ratings mean. I know the ratings on CDS, MBS, and other derivatives were hogwash. But I cannot do the kind of due diligence required to rate a company and it's debt instruments in the kind of time I had, or even if I had unlimited time if I am competent to do such an evaluation. I had to use some criteria, and a combination of Moody's and S&P ratings seemed sensible, as well as noting when the ratings became effective, and if they were on credit watch currently. I also used my own sense of the company as an ongoing concern to guide my choices as well.

I looked at the Muni's but more at the couples tax returns from the last coupe years, they just aren't gonna get the tax benefits of muni's to be meaningful. I looked at the rev's as well, but then I ran into the same thing, as well as only the long maturities having near the yield I needed. Also NY only issued so many bonds and I was trying to get the monthly payments. All these things made Muni's sub optimal.

I agree with your take on interest rates, but the couple was more concerned with locking in a predictable monthly income which in combination with their pensions, SSRI, and the gentleman's military disability pension, would reasonably assure them of both the lifestyle to which they aspire and an inheritance for their children and grandchildren. They also did not want to have to be burdened with trading the bonds over the years as they matured. By the time any of the bonds come to maturity they will probably be ok with using off the principle or using CD's.

Thanks for your advisers eye view on this. I probably would have saved a lot of time by talking to you beforehand.

Again, it sounds like you did the best that can be expected with the market backdrop. Given the couple's objective it sounds like you met it well and they should be fine. I was just throwing some things out there for consideration. I am by no means an adviser. I have some textbook knowledge on the industry and that is really all. However, if you'd ever like to bounce an idea off of someone I'll be more than happy to do what I can.

Lastly, it sounds like this couple is elderly given they are drawing SSRI -- unless due to disability. What type of account are these securities being held? Have they considered a JTWROS or perhaps even a trust? This could make the estate issue a lot easier and less expensive if one should pass away.

[aiki14]

Again, it sounds like you did the best that can be expected with the market backdrop. Given the couple's objective it sounds like you met it well and they should be fine. I was just throwing some things out there for consideration. I am by no means an adviser. I have some textbook knowledge on the industry and that is really all. However, if you'd ever like to bounce an idea off of someone I'll be more than happy to do what I can.

Lastly, it sounds like this couple is elderly given they are drawing SSRI -- unless due to disability. What type of account are these securities being held? Have they considered a JTWROS or perhaps even a trust? This could make the estate issue a lot easier and less expensive if one should pass away.

Their attorney did their will and I was only called upon to set up a bond portfolio as a favor. The account is already set up as JTWROS, in a brokerage account at Morgan Stanley. They are mid 70's. The hardest thing is trying to explain the intricacies of the various accounts and strategies available, they just like it kept simple.