Bargain hunting should not be limited to the mall this holiday season, as BondSavvy just presented four new corporate bond investments we believe are bargains. We provide a preview of our four investment recommendations in the below table (turn mobile phones landscape for best viewing). Subscribe to learn the full details of these recommendations and to gain access to our other 19 'buy' recommendations.Summary of BondSavvy's December 12, 2019 Bond Investment Recommendations
|Bond 1||92.50||10.8%||3.4x||High Yield||< 5 years|
|Bond 3||99.25||5.3%||2.9x||Split-Rated||< 5 years|
|Bond 4||83.10||7.7%||3.5x||High Yield||< 10 years|
** "High Yield" means the bonds were rated below investment grade by both rating agencies. "Split-Rated" means the bonds were rated investment grade by one rating agency and below investment grade by another.
You'll notice that none of our recommendations were rated investment grade by both Moody's and S&P. The reason for this is that, as a result of the rally in US Treasurys, investment-grade corporate bonds have rallied significantly over the last year, and there are few compelling buys to be had. For investment-grade corporate bonds priced between par and 110 on Fidelity.com December 11, 2019, the median YTM was 2.3% (yawn). Finding investment-grade bond yields much higher than this requires investors to look at corporate bonds priced at 115 and above, and, since capital appreciation is a key goal of ours, we generally stay away from such highly priced bonds.
What impact have Treasury bonds had on investment-grade corporate bonds?
Investment grade corporate bonds trade as a spread to their benchmark US Treasury. What does this mean in layperson's terms? Suppose a corporate bond has a 12/15/29 maturity date and it has a YTM of 4.00%. There's a 10-year Treasury note that matures right around 12/15/29, and it has a YTM of 1.90%. As the yield on this Treasury note increases or decreases, the yield on the corporate bond will increase or decrease. The "spread" (aka as the "credit spread" or the "spread to Treasurys") is the difference between the corporate bond's YTM and that of the benchmark US Treasury. In this case, the spread is 2.10%. Generally speaking, the spread will shrink if a bond's credit quality improves and increase if the corporate bond's credit quality worsens.
The credit spread represents the extra yield a corporate bond investor receives above the 'risk-free' yield provided by the benchmark US Treasury. We would argue that the US government is hardly risk free, but that's a topic for a different blog post.
As shown in the below chart, Treasury yields fell significantly between November 2, 2018 and September 4, 2019. This caused the yields on most investment-grade corporate bonds to fall, which caused prices to increase to their current levels. Since bonds rated below investment grade do not trade as a spread to US Treasurys, the overall interest rate environment does not impact these bonds. As a result, we have found more compelling buys for bonds rated below investment grade since these bonds were not buoyed by the rally in US Treasurys.
US Treasury Yields 2018-2019
Individual corporate bonds can complement stocks investors own, as they can achieve strong returns with less risk than stocks. Not many investors understand bonds, which is why educating investors is such a big part of BondSavvy's mission. You'll find a treasure trove of bond investing education at the BondSavvy blog.
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