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When all is wonderful we can trust everyone and we assume we are treated fairly. Unfortunately when it comes to bond investing one is not always treated fairly. Much depends on the environment when the bonds were issued as to the fairness of the terms and conditions.

Great Success

November 11th, 2013 by Kurt L. Smith
  • The financial markets spent most of October peaking so why should I add my usual dose of downer?  Instead, in the spirit of thanks and Thanksgiving, why not look back at some of our successes and revisit why we choose the path we do.

    Not only have Stocks continued their seemingly straight up run but all other assets have firmed in price of late.  US Treasury yields topped in August at 3% for ten years and despite a government shutdown prices did nothing except seemingly rise since.  We have a new Federal Reserve chair nominee, Janet Yellen, so it appears to not only be more of the same (continuous easing) from the Fed, but a lot more of the same.  Stock markets rejoiced!

    Municipal bonds, used to playing the role of slow follower, did just that and have rallied the past couple of months.  Yet despite such firmness, lack of supply, strong demand, or whatever pundits like to add, long-term municipal bond prices have recovered little ground compared to their high prices of a year ago.  Great damage has been done to portfolios containing long-term bonds and despite what some call a “buying opportunity” I believe the long-term trend for Bond prices in general and municipal bond prices in particular has been set.  Yields will rise; prices will fall.

    Our strategy nicely side-stepped the bubble mentality in Bonds from 2011 to 2012 while long-term municipal bond prices have essentially gone nowhere over the past five-plus years.  In that time we have seen three price breakdowns of over ten percent and yet these are municipal bonds we are talking about.  Take a look at the yields for the Allen ISD bonds below.  Yields were even lower at this time last year and now those long-term bonds are down about ten percent in price as well.

    At The Select ApproachTM we take a decidedly different approach.  In the midst of bubble economies we start with the premise that we don not trust municipalities further than we can throw them.  It is not that municipalities are not trustworthy, nor have they largely refused to repay us as bondholders.  History says otherwise.  We aren’t buying for yesterday however; we are buying for tomorrow.

    The problem with bubble economies is just how insidious they become.  When all is wonderful we can trust everyone and we assume we are treated fairly.  Unfortunately when it comes to bond investing one is not always treated fairly.  Much depends on the environment when the bonds were issued as to the fairness of the terms and conditions.

    With the Bond markets largely rallying and expanding from the mid-1980s to the early 2000s we noticed bondholders willing to accept less and less collateral (if any) and also bondholders willingness to accept greater and greater leverage.  Trust us the issuers said and in a rallying and expanding market many investors, knowingly or not, did just that.

    Trust perhaps, but verify, always.  We want to make sure we have a solid revenue stream and most of all I am looking for plenty of fudge factor.  Leave leverage to the movers and shakers in the municipal bond market: those issuers who regularly issue billions of dollars in bonds, keeping Wall Street happy.  Leave us the boring, deleveraging issues….please!

    Active issuers in the municipal marketplace usually do not need our help selling their bonds.  Again, look at the Allen ISD yields below.  At .11%, .24% and .42% for one, two and three year bonds it evidently indicates strong demand and high prices for those short-term offerings.  Bonds of similar structure and credit will usually be marketed with similar yields therefore it is best for us to take a different tack if we hope to deliver worthwhile yields for similar short-term periods.

    Here I will point to the success in your own portfolio, on your own statement and in your own experience with the short-term municipal bonds we have purchased over the past several years.  Short-term bonds of less than one year may have netted only 1% or so but most of our bonds last longer and most do better with some doing much better.  As I look at the results of bonds that have come due in the past couple of months I see 1%, 1.25%, 1.50%, 2% and better, 3% and better and for bonds purchased two or three years ago, even 4% and better.  Our results are earned all without using Puerto Rico to boost yields and, most importantly, with an attitude of not trusting the municipality any further than I can throw them.

    Of course with all the good news in the financial markets (re Stocks) we should have good results.  After all there hasn’t been many municipal bankruptcies (Jefferson County, Stockton, San Bernardino, Detroit) or many bankruptcy scares (Puerto Rico).  This is where I will detour from my thanks and Thanksgiving and ask you to read but a few of my latest 2013 missives.  The trend for Bonds has changed, it changed in 2012, and experience has shown that prices can go from bad to worse (see Gold) despite a couple of months of firmness in the Bond markets.

    With The Select ApproachTM you have something (yield) and also something I believe will take on renewed importance in the coming months: liquidity.  Your bonds are worthwhile because they yield you more than the Allen ISD bonds (hopefully substantially more) and you don’t have to buy 10 year, 20 year or more bonds in order to get it.  When today’s good news turns into tomorrow’s increasingly troubling times, you should be pleased with your shorter-term bonds with good fudge factor.

    Allen   Independent School District, TX
    Moody’s: Aaa (Aa2 Underlying)  S&P: AAA (AA Underlying)
    Permanent School Fund Guaranteed
    DUE 2/15 DATED 10/15/13 MATURITY: 2/15/2035
    SALE AMOUNT: $54,000,000

    YEAR MATURITY COUPON YTM*
    1 2014 3.00% 0.11%
    2 2015 4.00% 0.24%
    3 2016 4.00% 0.42%
    4 2017 5.00% 0.64%
    5 2018 4.00% 0.93%
    6 2019 5.00% 1.34%
    7 2020 5.00% 1.70%
    8 2021 5.00% 2.02%
    9 2022 4.00% 2.33%
    10 2023 4.00% 2.49%
    11 2024** 3.00% 2.80%
    12 2025** 3.00% 3.11%
    13 2026** 3.125% 3.30%
    14 2027** 3.375% 3.50%
    15 2028** 3.50% 3.65%
    16 2029** 3.625% 3.78%
    17 2030** 4.00% 3.82%
    18 2031** 4.00% 3.91%
    19 2032** 4.00% 4.00%
    20 2033** 4.00% 4.06%
    21 2034** 4.00% 4.12%
    22 2035** 4.00% 98.000

    *Yield   to Worst (Call or Maturity) **Par Call: 2/15/2023
    Source: Bloomberg
    This is an example of a new issue priced the week of 10/31/13
    Prices, yields and availability subject to change

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