Forget Treasuries — Buy Junk Bonds Instead

by Lawrence Meyers | August 30, 2012 7:15 am

A couple of weeks ago, I wrote that bond yields are dead[1] for the foreseeable future, and that investors should seek out other forms of dividends and fixed income. A few days later, we learned that Warren Buffet’s Berkshire Hathaway (NYSE:BRK.A[2], BRK.B[3]) ended its bet on municipal bonds[4] five years early. Five years!

With interest rates expected to be held down by the Fed, bond yields that might normally be attractive, or provide a nice fixed income stream, or offer a nice portfolio hedge, just aren’t there anymore. Municipalities are facing serious fiscal challenges and are in danger of default.

That’s why I have exited almost all my bond investments, and I think you should, too.

There are more attractive yields available that, in my opinion, offer more attractive risk-reward upside, and that’s in junk bonds. It’s easy to dismiss junk bonds as being far too risky for income investors, but choosing the right company in the right circumstances, or buying a junk bond ETF, will mitigate much of that perceived risk.

Sometimes a company’s credit rating might be challenged for reasons that may not be intrinsic to their long-term survival. All of it depends on the real-world risk that the company will default on their debt payments, and sometimes the reality of that risk differs from perceived risk.

You can buy individual junk bonds by contacting your broker. Here are a few that I find attractive:

Cooper Tire & Rubber (NYSE:CTB[5]) has $240 million in cash, $337 million in debt and $165 million in trailing 12-month free cash flow. The company has senior unsecured notes maturing in December 2019 with a 6.83% yield to maturity. That the bond trades at 107.00 cents on the dollar, more than par, tells us that the market does not believe this is anywhere close to default. Yet it’s considered junk.

Gap Inc. (NYSE:GPS[6]) might not be the clothing juggernaut it once was, but with $2 billion in cash and $1.57 billion in debt and ongoing free cash flow in the upper nine figures, there’s no reason to shy away from the company’s 5.75% senior unsecured bonds.

Weyerhauser (NYSE:WY[7]) is one of the world’s premier lumber companies, and while profits have been falling and free cash flow only amounts to $200 million, there’s no reason why the company’s senior unsecured notes maturing in 2027 have a 6.95% coupon and also trade near 107.00 cents on the dollar, for a yield to maturity of 6.235%. It’s another no-brainer to me.

If you prefer to stick with a diversified ETF so you don’t get caught with your junk exposed on a single issue, then look at the PowerShares High Yield Corporate Bond Portfolio (NYSE:PHB[8]). It yields a healthy 5.27% and is up 5.28% YTD.

SPDR Barclays Capital High Yield Bond ETF (NYSE:JNK[9]) is the most heavily traded ETF in the sector, yields 7.13% and is up about 7.5% YTD. I like this choice a bit more, as the holdings are more diversified across different sectors.

PowerShares Senior Loan Portfolio (NYSE:BKLN[10]) kind of splits the difference, with a YTD return of 6.27% and yield of 4.99%. The ETF has fewer holdings, but spreads its risk around more to smaller names.

As of this writing, Lawrence Meyers[11] did not hold a position in any of the aforementioned securities. He is president of PDL Capital, Inc.[12], which brokers secure high-yield investments to the general public and private equity. You can read his stock market commentary at[13]. He also has written two books[14] and blogs about public policy[15], journalistic integrity[16], popular culture[17] and world affairs[18].

  1. bond yields are dead:
  2. BRK.A:
  3. BRK.B:
  4. ended its bet on municipal bonds:
  5. CTB:
  6. GPS:
  7. WY:
  8. PHB:
  9. JNK:
  10. BKLN:
  11. Lawrence Meyers:
  12. PDL Capital, Inc.:
  14. written two books:
  15. public policy:
  16. journalistic integrity:
  17. popular culture:
  18. world affairs:

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