Yield to Worst

Investment Grade bonds: possibility of guaranteeing attractive returns

Marie Vonotna

Introduction

There is no need to recount the turmoil of the market in 2022, the rise in inflation and the sharp rise in interest rates following the movements of the Fed and the action of the market. At the time of this writing, the yield on 10-year Treasury bonds is to just under 4.0%, compared to 1.8% at the start of 2022. This sharp rise has led to a decline in all fixed income categories, with the highest quality corporate bond indices falling by more than 20% this year (for example NYSEARC:LDQ, iShares Investment Grade Corporate Bond ETF). While we cannot predict the direction inflation and interest rates will take, we believe that most, if not all, of the “bad news” related to these factors has been priced into bonds. This has resulted in what we believe is a potentially generational opportunity to secure excellent returns in the least risky corporate bonds, those rated investment grade. Some analysts believe the next 10 years could be another “lost decade” for stocks where stock market indices rebound but ultimately offer little return over that period. One solution to uncertain market returns and volatility, at least in terms of new funds available for investment, is to secure attractive returns in investment grade bonds for the next 4-7 years.

The chart below shows the LQD index fund’s sharp decline this year and how it compares to previous decades. The last time the index fell to the current level was during the 2008-2009 period, when it looked like the global financial system was collapsing.

LQD Price Chart

LQD Price Chart (Yahoo finance)

While investing in the index or other bond ETFs is a sensible decision, we prefer to hold individual obligations that have a known maturity date and yield. This way we know exactly when our principal will be repaid in full and exactly the income generated by the bond portfolio. Assuming the bond portfolio is held to maturity, the only key risk is bankruptcy – if one of the bond issuers defaults, they may not repay all or part of the major. But with investment-grade bonds, that possibility is extremely small based on historical data, and with bond selection and portfolio diversity, that risk can be further mitigated.

Bond Ideas

Below are some specific bonds that we have recently added to our clients’ portfolios. Note that many investment grade bonds are trading at significant discounts to face value because they were issued when yields were much lower, and market movement to adjust those yields to current market conditions means that bond prices must fall. Unless current income level is the most important factor, it shouldn’t matter to an investor, as the yield-to-maturity measure is the key indicator of annualized return taking into account all The factors.

Main Street Capital (MAIN), 3.0% on 07/14/2026, offered at approximately 85.1, yield to maturity 7.7% (CUSIP 56035LAE4, rated BBB-). Main Street is considered one of the premier BDCs, with a market capitalization of $2.5 billion, 2x asset coverage and consistently trading at a premium reflecting its strong performance. Note that much of this return is built into its discount price; while the current yield is only 3.5%, an investor will earn about an additional 4% per year when the bond is fully repaid in 2026 compared to the purchase price of 85%. We see several attractive opportunities in BDC large cap investment grade bonds in addition to Main Street, with yields in the 7% to 8% range.

Real Estate Spirit (CRS), 3.2% on 01/15/2027, offered at approximately 87.3, yield to maturity 6.7% (CUSIP 84861TAE8, rated BBB/Baa2). Spirit is a net leasehold REIT with a diversified portfolio of commercial and industrial properties, with a market capitalization of $4.8 billion. The chart below shows how this bond’s yield has skyrocketed over the past few months (the chart will be similar for all bonds discussed here):

SRC bond price chart

SRC bond price chart (Interactive brokers)

Kinder Morgan (KMI), 7.0% on 10/15/2028, offered at approximately 102.8, yield to maturity 6.4% (CUSIP 880451AV1, rated BBB/Baa2; note that these bonds may be listed under the original issuing entity which was later acquired by Kinder Morgan , called Tennessee Gas Pipeline Co.). Kinder Morgan is one of the largest gas pipeline companies with a market capitalization of $38 billion. This bond is trading at a slight premium unlike previous ideas.

For even more risk-averse investors, a bond portfolio can even take credit quality up a notch, in A-grade bonds and above, with some yields available today in the high 5% to 6% range. %. (Remember that credit rating is not the final word in credit quality and should not be the only source of trust; for example, Credit Suisse (CS), which is being restructured, is still rated A2/A). Some obligations to consider today:

Bank of America (BAC), 6.0% on 20/10/2027offered at par 100, yield to maturity of 6.0% (CUSIP 06048WZ29 , rated A2/A-).

Real Estate Revenue Corporation (O), 3.0% on 01/15/2027offered at 90, yield to maturity of 5.7% (CUSIP 756109AS3, rated A3/A-).

Note that with the current yield curve, which predicts lower yields in the future, a longer duration does not necessarily provide higher yields for bond investors and in some cases is lower. For example, some Bank of America bonds maturing in 2034 and 2036 yield between 5.6% and 5.7%. We believe that the current “sweet spot” for bonds is between 4 and 7 years (consider a laddered portfolio of bonds from each year); this maturity range carries high duration risk, but allows an investor to take advantage of the excellent yields available today and lock them in for a reasonable period of time.

Conclusion

For existing bondholders, there is not much to do, all bond portfolios have lost value this year. Our general recommendation is to continue to hold, collect income and eventually the bonds will mature or market yields will come down. But for new funds or investors looking to step away from the stock market, we see today’s investment grade bond market as a unique opportunity to secure annual returns of 6% to 7%+ with the safety of investment grade bonds. company of the highest credit quality. . A diversified portfolio of individual bonds allows an investor to ignore market volatility and simply earn the return of the portfolio each year, while holding the bond until maturity. In the meantime, the interest earned can be reinvested in new bonds to benefit from compound interest. While we can’t predict where markets and rates are headed next (and after 30 years of professional investing, we’ve learned no one else can either), it seems to us that now may be an opportunity unique over several decades to consider this asset class, and the window of opportunity to profit from it may last much less than it seems.

Please note that Downtown Investment Advisory currently holds the bonds shown in this article in client and personal accounts, and may have added/will add positions at any time before or after the publication of this article. It is important to note that fixed income investments carry various risks such as default risk and interest rate risk which should be considered by investors. Please see Downtown Investment Notice profile page for important disclaimer language, which is an integral part of this article.