Common Questions about Investing in Bonds

What is a corporate bond?

Corporate bonds are debt issued by companies that pay the bondholder interest and return the bond's principal at maturity.  For example, the Albertsons 7.45% '29 bond pays the bondholder a coupon of 7.45% each year and then returns the face value of the bond -- $1,000 per bond -- in 2029.  If an investor owned 10 of these bonds, he would receive $745 of interest each year, paid semi-annually.

Today, BondSavvy only recommends bonds issued by US-based companies.  These companies range in credit quality and, as a result, investors can select from a variety of investment choices offering different levels of risk and return.

How do corporate bonds work?

Corporate bonds are issued by companies and create a number of obligations the issuing companies must fulfill that are more stringent than when companies issue stock.  With corporate bonds, issuing companies pay bondholders interest semi-annually.  For example, suppose you owned a bond that paid a 5% coupon and you owned 10 bonds.  For each bond you owned, you would receive $50 of interest each year and that interest income would be split into two semi-annual payments of $25 each.  

What is the face value of a bond?
The face value of a bond is $1,000.  This is also known as the par value of a bond.  

How are corporate bonds quoted?
Individual corporate bonds are quoted as a percentage of their face value.  Therefore, if a bond is quoted at 95.00, that bond is being valued at 95% of the $1,000 face value, or $950.  Bonds that are quoted at less than their par value are said to be trading at a discount.  Bonds trading above par value are said to be trading at a premium.

How much will I pay when I buy a bond?
Suppose you execute a trade today where you buy 10 bonds at a price of 90.  Here's how the math works: First, each bond you bought cost $900.  Since you bought 10 bonds, you will pay $9,000 in principal.  In addition, you owe accrued interest since you will receive the full interest payment the next time the company pays interest.  Bonds pay interest semi-annually on either the first or the fifteenth day of a month.  For example, a bond may pay interest on a) February 15 and August 15 or b) on March 1 and September 1.  Suppose you bought the 10 bonds on July 15 and it last paid interest on February 15.  Let's assume the coupon of the bond is 5%, so the 10 bonds would pay the investor $500 of interest annually.  In this example, interest will have accrued for five months plus two days, as interest accrues until the day immediately before the trade settles, which is two business days following the trade date.  Interest typically accrues based on a 360-day year with 12 30-day months.  Five months and two days of accrued interest is equal to: ((30 days*5 months)+2 days) / 360 = 42.2% of total annual interest or $211.11.  On August 15, the investor who just bought the 10 bonds will receive $250 of interest, which is why she needed to pay the $211.11 in accrued interest to the selling bondholder.       

What are covenants?
Bond covenants are effectively the do's and don'ts bond issuers must follow to stay in compliance with the bond indenture, a contract between issuer and bondholder.  They govern the behavior of a company to help ensure bondholders are paid interest and receive a return of principal at maturity.  An example of one financial covenant is the "Leverage Ratio," which limits the amount of debt a company can issue relative to its EBITDA, or earnings before interest, taxes, depreciation and amortization.  Some investors believe covenants add 'complexity' to bonds, but, once investors understand them, they will see how they are in place for the benefit of bondholders.  Be sure not to look for similar covenants in a stockholders' agreement, as you will never seem them in there.

Why should I own corporate bonds?

Corporate bonds offer many advantages compared to stocks, bond mutual funds, and municipal bonds.  We review all of these advantages here.  

What are some corporate bonds advantages?

Individual corporate bonds offer investors strong returns but with less downside than stocks.  They offer greater transparency than bond funds and ETFs as you know precisely the security in which you are investing and can invest according to your risk tolerance and investment returns objectives.  If you own an individual corporate bond, you pay a fee when you buy it and if you sell the bond prior to maturity.  This fee structure can offer considerable savings to the recurring fees investors pay when investing in bond funds and bond ETFs.

We believe there is far greater financial reporting transparency for corporate bonds compared to municipal bonds, as corporate bond issuers are required to report their financial performance quarterly and have other reporting requirements when material events occur at the company.  Municipal bond issuers have far less stringent reporting requirements.  Taken together, we believe investors can better assess the value of a corporate bond than a municipal bond since there is a far greater level of financial information available to corporate bond investors.  This presents opportunities for corporate bond investors to achieve strong capital appreciation, and, as a result, after-tax returns that can exceed those of municipal bonds.

Please click here for a detailed comparison of the advantages of individual corporate bonds compared to bond funds, stocks, and municipal bonds.

What corporate bond returns should investors expect?

Many bond investors believe a bond's yield is the only return you can achieve.  Further, many media outlets such as CNBC often say "with the 10-year Treasury yielding 3%, why would you ever invest in bonds?," implying the only bonds one can buy are Treasurys.  Payment of a fixed coupon is one of the many advantages of owning corporate bonds; however, we focus just as much on buying bonds that can increase in value and achieve a strong total return.  Our goal is to recommend corporate bonds that, over a two- to four-year period, can achieve annualized rates of return of 7-9% for investment-grade corporate bonds and 10-15% for high-yield corporate bonds.

With strong capital appreciation, after-tax returns from corporate bonds can often exceed investment returns from municipal bonds given the more favorable tax treatment of capital gains compared to interest income.

When evaluating investment performance, investors should be wary of the prices they see on their brokerage statements, which do not show the bond's total return and often undervalue the bond held.  The price shown on an investor's statement is called "an evaluated price," which is an estimated price at which a large institutional money manager could sell the bond.  Investors owning smaller quantities can often achieve better price execution than investors needing to sell $1 million plus of bonds, so always check a bond's depth of book to see what the current market price of the bond is.

What corporate bond research and corporate bond analysis does BondSavvy provide?

BondSavvy provides CUSIP-level corporate bond research, which includes between 20-25 new corporate bond investment recommendations each year.  Many investors and investment advisors do not have the time to read 10-Ks and listen to company earnings calls and do the financial analysis necessary to determine which corporate bond investments can outperform the market.  We do all of this work for you and provide the information investors need to make successful corporate bond investment decisions.

BondSavvy determines which investments present the most compelling risk-reward investment opportunities.  After we make an initial investment recommendation, we monitor company earnings releases, SEC filings, and bond performance to determine if an investment recommendation has changed.  We then advise subscribers to either buy more of the same bond, reduce holdings, or to sell all remaining bonds of that CUSIP.

How is BondSavvy different from a bond investment newsletter?

Many bond investment newsletters publish lists of hundreds of bonds and then leave it up to subscribers to figure out which ones to buy.  BondSavvy takes a different approach and narrows down the corporate bond investment universe to a small number of bonds from which investors can choose.  We review each bond recommendation during The Bondcast, an exclusive, subscriber-only webcast where we discuss the issuing company's business, industry trends, and financials. We then update our recommendations, including if and when we recommend to sell bonds.

Click here to learn how to subscribe to BondSavvy and see all of our corporate bond investment recommendations.

How is BondSavvy different than typical credit research and fixed income research?

BondSavvy makes CUSIP-level corporate bond investment recommendations whereas most credit research provides issuer-level analysis.  Issuer-level analysis would be sufficient if companies only issued one bond, but each company can issue many different bonds, sometimes over 100.  Our goal is to assess which individual corporate bonds present compelling value and can appreciate in price.  We also evaluate an individual bond's liquidity, including how often the bond trades and how many dealers are providing quotes on both the bid and offer side.  We do this since a key part of our strategy is to sell bonds prior to maturity to lock in capital appreciation and maximize returns.  It's therefore crucial to understand a bond's liquidity prior to buying it. 

We take the step traditional credit research does not, which is to narrow down individual corporate bond investment opportunities to a small number we believe can outperform the market.

What role do individual corporate bonds play in income investing?

Individual corporate bonds are a crucial component of income investing as they provide yields generally higher than Treasury bonds and muni bonds. Investors can choose from a wide variety of bonds based on their risk tolerance and investment return objectives.

Owning individual bonds helps income investors create a more precise investment plan than is possible with bond funds and ETFs.  When you own an individual corporate bond, you have a contract with the bond issuer to pay you a fixed rate of interest and to return your principal at maturity.  This enables investors in individual corporate bonds to build a reliable income stream, as compared to bond funds and ETFs, whose income streams are less predictable since the underlying holdings can change over time.

A key benefit to BondSavvy's approach to corporate bond investing, is that we seek to complement a bond's income stream with capital appreciation by recommending what we believe are undervalued corporate bonds that can increase in price and achieve strong total returns.  

Does BondSavvy advocate corporate bond trading or corporate bond investing?

Technology has advanced so corporate bond investors can trade bonds and execute at competitive prices.  That said, we do not advocate 'day-trading' of bonds but rather advise holding corporate bond investments for, generally, two to four years depending on how a bond and its issuing company are performing and the upside potential remaining in the bond.  We look to hold bonds for as long as we can maximize the return on that given bond.  While there are thousands of bonds that trade on a given day, there are not thousands - or even hundreds - of 'good' bonds that we believe are undervalued and can outperform.  This is why, if a bond spikes in price a few days after we recommend it, we continue to hold the bond until we believe we have maximized the bond's total annualized return.

A key BondSavvy differentiator is that we believe investors are better served NOT holding bonds until maturity, as this typically reduces returns, especially after a bond has achieved significant capital appreciation.  We therefore carefully study a bond's trading activity and available liquidity prior to recommending it so we know our ability to sell the bond prior to maturity.  

What credit analysis does BondSavvy conduct when evaluating investments?

BondSavvy identifies undervalued corporate bonds it believes can outperform the market.  To identify these corporate bonds, we must understand how bonds are priced relative to their credit risk and interest-rate risk.  Please see the below slide that was part of the May 31, 2018 edition of The Bondcast.  It reviews the key metrics we examine when evaluating corporate bond investments.  Below the table is a description of the select terms.  Click here to view this sample edition of The Bondcast.


Leverage Ratio: 
Total debt divided by EBITDA. If this ratio is low (1-2x), it means the company has a low amount of indebtedness (“leverage”) relative to its earnings. High-yield issuers have higher debt levels relative to earnings and have Leverage Ratios typically between 4-8x. Note that “EBITDA” is an acronym for Earnings Before Interest, Taxes, Depreciation & Amortization. It shows how much cash a company generates from operations and what it has to pay its interest, taxes, and capital expenditures.

Interest Coverage Ratio:
EBITDA divided by interest expense. The higher this is, the more cash flow a company has to pay its interest expense. If Interest Coverage is low, a company may have difficulty paying interest if its business hits a rough spot. Interest Coverage is usually 2-4x for high-yield issuers and often over 10x for investment-grade issuers. 

Upcoming Maturities
If a company doesn't have a bond maturing for seven years, chances are it's going to be money good between now and then unless the company can no longer cover its interest payments.  If, however, a company has many near-term maturities, is struggling financially, and has questionable ability to refinance its upcoming maturities, bondholders can be in for a tough ride.

Liquidity
We want to understand all sources available to pay for interest expense, capital expenditures, and upcoming debt maturities.  To do this, we evaluate the company's cash on hand, investments, and capacity on any bank lines of credit.

What are the best corporate bonds to invest in and the best bonds to buy?

BondSavvy makes CUSIP-level corporate bond investment recommendations that identify undervalued bonds that can drive strong total returns.  We do not recommend bonds that are trading at a material premium to par value, as these bonds have limited upside as show in this blog post. 

We review thousands of corporate bonds to create a short list of investment opportunities. We then conduct detailed analysis on these bonds to determine which bonds have the most upside relative to the company's financial situation and other bond investment opportunities available to investors. We conduct credit analysis on both investment-grade and high-yield corporate bonds to determine which bonds provide the most compelling risk-return opportunities.  

This is a very different approach than the typical laddered bond portfolio. When investors create bond ladders, their focus is on the maturity date of the bond and not whether that bond is a good value or not. In our opinion, this limits an investor's options and reduces returns. Further, selling bonds before maturity is a key component of our approach as it enables investors to lock in capital appreciation and increase returns.


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