Bonds, Muni's and BAB's

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Jan 6, 2010 2:53 pm

I want to have a discussion, perhaps a debate, about individual bonds vs. bond funds and/or closed-end bond funds.  Also, I want to pose some questions about the risk of muni's and the opportunity that muni's have in 2010.

 
First, I have historically bought bond funds or closed-end bond funds.  Sure, there is a management fee, but if the yield is good, why not?  I don't have to worry too much about individual default and I believe the managers can get better deals on bonds than I can.
 
So am I missing something for those of you that do individual bonds?  I mean, you sell someone an individual bond with a 10 or even 20 year maturity and have to make sure it doesn't default.  I can sell a UIT or bond fund and have immediate liquidity or at worst 1 year.  The yields are attractive, average credit quality is good, so what's the deal?
 
Secondly, about muni's.
 
So we have heard BAB's may not be issued after 2010.  From what I've heard, there will be a large amount of BAB's issued in 2010 before the clock runs out.  This quite possibly means not as many muni's will be issued.  If that's the case, then muni's would be in higher demand, which will bode well for their values.
 
In addition to that, as tax rates go up, muni's become more attractive.  So I've been buying and will continue to buy.  I don't see much risk in local municipalities being able to meet their debt obligations, but I'm open to debate that with some of you.

Any opinions out there about this stuff?
Jan 6, 2010 3:18 pm
mlgone:

Are you worried at all about when rates start to move up?

 
Only if your maturities are long.  I've been buying short duration funds, senior notes maturing eery 60-90 days, and muni's no longer than 7 years.  I feel good about it.
Jan 6, 2010 3:36 pm
mlgone:

I have slowly been exchanging some Pimco Total Return with Pimco Real Return to protect against those moves

 
Interesting.  I'll have to look at that as well.  I've used the Pimco All Asset and All Asset All Authority funds as well.  It's been awhile, so I should sit down and review it.
Jan 6, 2010 3:38 pm

With munis, I almost always buy individuals (if they have a "real" amount to invest), as normally these clients are buying purely for the income, not really caring about the MKT value.  If you buy at least 10 different munis, sure you have somes default risk, but it is very, very small.  I don't buy CA bonds, and I don't buy anything below BBB (and mostly only A and above).  I do use state-specific muni funds for div reinvestments if they don't need the income right now.

 
So I think it really depends on what the purpose of the bonds are.  For me, if it is PURELY for the income, I buy individuals (or occassionally UIT's).  If it is part of a dynamic asset allocation portfolio (meaning you rebalance and make adjustments, etc.), I use funds or ETF's.
 
I just think individual bonds maximize yield for people that are living off the income.
 
Personaly, I bought a ton of muni's over the past year at GREAT yields, and have no intention of ever selling them.  I have had to sell some for clients because they rose so much in value, that they wanted the profits, even though I objected.  When you have in-state high-quality muni's that you bought close to 6% yield, you keep them!  Some total return funds would sell them for gains.
Jan 6, 2010 3:47 pm
B24:

With munis, I almost always buy individuals (if they have a "real" amount to invest), as normally these clients are buying purely for the income, not really caring about the MKT value.  If you buy at least 10 different munis, sure you have somes default risk, but it is very, very small.  I don't buy CA bonds, and I don't buy anything below BBB (and mostly only A and above).  I do use state-specific muni funds for div reinvestments if they don't need the income right now.

 
So I think it really depends on what the purpose of the bonds are.  For me, if it is PURELY for the income, I buy individuals (or occassionally UIT's).  If it is part of a dynamic asset allocation portfolio (meaning you rebalance and make adjustments, etc.), I use funds or ETF's.
 
I just think individual bonds maximize yield for people that are living off the income.
 
Personaly, I bought a ton of muni's over the past year at GREAT yields, and have no intention of ever selling them.  I have had to sell some for clients because they rose so much in value, that they wanted the profits, even though I objected.  When you have in-state high-quality muni's that you bought close to 6% yield, you keep them!  Some total return funds would sell them for gains.
 
Ok, see, this is exactly my question.  I've been buying Muni UIT's for income and reinvestment, that are yielding 6.5% net of fees, average credit rating of A and average duration of 7 years, 6 month cdsc.
 
I just don't see the value to the individual bond here. 
Jan 6, 2010 6:41 pm

Individual bonds come with a maturity date. Regardless of what happens in the market the client gets their money back on that date.


Individual bonds are pure income instruments. No muss no fuss, just income generating machines unencumbered by fees. you get exactly what you sign up for.
 
Individual bonds are not subject to change. There are no surprise notices that the manager, to accomodate new shareholders, or through some other market blunder, has to cut the dividend.
 
Individual bonds are not subject to management f*** ups. Ok, the managers guess wrong on that big position and now the fund is down 10% with no way to get that money back.
 
Individual bonds aren't sold at the whim of an investment manager who sees his career passing before his eyes. The manager was long, lost money, and now needs to get short, he does so locking the loss and killing the income. This has happened more times than i can count.
 
Most bond funds are now managed for total return. This is done because most funds are sold as part of a fee driven asset allocation program. Because income generation is a secondary consideration for the fund's managers income projection for retirement planning is impossible.
 
UIts charge managment fees for putting together a ready made portfolio of bonds. The fees can negate most of the price advantages, if any, the managers may have received through their buying power or expertise. As well, one must carefully and fully understand all the call features of every bond in the portfolio, the relationship those calls have to the purchase price of the bonds, and that relationship to the current price of the UIT. It's possible to lose a lot of money through any misunderstanding of those relationships.
 
All that said, do i use bond funds? Yes, mostly for high yield bonds where it's safer to buy a fund than an individual bond. Also, for clients lesser amounts to invest and finally where there is a clear price/yield advantage.
Jan 6, 2010 7:35 pm
snaggletooth:
B24:

With munis, I almost always buy individuals (if they have a "real" amount to invest), as normally these clients are buying purely for the income, not really caring about the MKT value.  If you buy at least 10 different munis, sure you have somes default risk, but it is very, very small.  I don't buy CA bonds, and I don't buy anything below BBB (and mostly only A and above).  I do use state-specific muni funds for div reinvestments if they don't need the income right now.

 
So I think it really depends on what the purpose of the bonds are.  For me, if it is PURELY for the income, I buy individuals (or occassionally UIT's).  If it is part of a dynamic asset allocation portfolio (meaning you rebalance and make adjustments, etc.), I use funds or ETF's.
 
I just think individual bonds maximize yield for people that are living off the income.
 
Personaly, I bought a ton of muni's over the past year at GREAT yields, and have no intention of ever selling them.  I have had to sell some for clients because they rose so much in value, that they wanted the profits, even though I objected.  When you have in-state high-quality muni's that you bought close to 6% yield, you keep them!  Some total return funds would sell them for gains.
 
Ok, see, this is exactly my question.  I've been buying Muni UIT's for income and reinvestment, that are yielding 6.5% net of fees, average credit rating of A and average duration of 7 years, 6 month cdsc.
 
I just don't see the value to the individual bond here. 


 
Muni UIT's yielding 6.5% net of fees?  First off, you can't reinvest them at the same yield (muni's yielding 6.5%, well, are no longer yielding 6.5%) as the market has pushed yields down.  Secondly, are these high yield muni's or CA only?  I just don't remember nationwide muni's yielding 6.5%.  But hey, maybe you know something I don't know.  Typically UIT's hold some great bonds, but the expenses push the yield down to a pretty average range.
Jan 6, 2010 7:36 pm

OK, I see that you mentioned "A" average credit rating.  I'm stumped.  Which company?

Jan 6, 2010 7:39 pm

Wait, are you talking about BAB's or tax-free's?  If they are BAB's then it makes sense.  I was thinking 2x tax exempts.  I actually had some decent luck with BAB UIT's due to lack of individual inventory.

Jan 6, 2010 7:46 pm
B24:
Muni UIT's yielding 6.5% net of fees?  First off, you can't reinvest them at the same yield (muni's yielding 6.5%, well, are no longer yielding 6.5%) as the market has pushed yields down.  Secondly, are these high yield muni's or CA only?  I just don't remember nationwide muni's yielding 6.5%.  But hey, maybe you know something I don't know.  Typically UIT's hold some great bonds, but the expenses push the yield down to a pretty average range.
 
Here is what I'm looking at:  https://www.ftportfolios.com/Broker/dp/dpsummary.aspx?fundid=6455
 
There are some HY and some CA, but not all of them.  And the monthly dividend is reinvested at current market price, so it could be 6.5% or higher or lower. 
 
There is some leverage, which is how they get the yield up there, but with the yield curve the way it is, it makes some sense to leverage in a sane way.
 
Trust me B24, I don't know anything you don't...for the most part.  But I know I don't know everything, so I'm still learning here.
Jan 6, 2010 8:45 pm

The next big financial crisis is going to be the states running out of money. Happening in California, New York, a lot of states got through 2009 by using stimulus money from the feds. I don't know how that will impact munis, but it's a concern. .... Personally I would rather lend money to Coca Cola or JNJ than a municipality. .... I've got a client with some California munis that I worry about. Yeah, California has a clause in their constitution that puts the munis at the top of the list when the bills comes due, you know they'll have a referendum to stiff the bond holders so they can pay float people like that guy on here a few weeks ago who was retiring with a 100k annual state pension for riding around in a fire truck.



Jan 7, 2010 1:01 am

BAB's are still an anomaly.  Higher yields than corps with 10-20 times less default risk.  This disparity will not last.  Individual bonds are easier to sell to new clients.  When they hear "sewer system" or "school district" or "hospital", clients assume they are safe, and they usually are.  "Mr Client, unless people stop using the bathroom, how safe do you think your money is?"  Individual bonds cost significantly less and I sell them against funds all the time.  "Mr Client, why pay your advisor 30% of your income when you could buy this G.O. school district rate and pocket the difference?"

Jan 7, 2010 7:51 am

UITs do most of what indiv bnds do (not all). I bet that after Lehman, CW, and CIT the $$$ going into UITs at Jones has skyrocketed. I remember it as being minimal before.


If a port takes big risks(like default risk) why not keep the bigger risks mostly to the equity side? Min risk on the income side by doing all bnds less than AAA in a pkg or an ETF. If they must have par value: UIT.
 
Jan 7, 2010 11:48 am
rankstocks:

BAB's are still an anomaly.  Higher yields than corps with 10-20 times less default risk.  This disparity will not last.  Individual bonds are easier to sell to new clients.  When they hear "sewer system" or "school district" or "hospital", clients assume they are safe, and they usually are.  "Mr Client, unless people stop using the bathroom, how safe do you think your money is?"  Individual bonds cost significantly less and I sell them against funds all the time.  "Mr Client, why pay your advisor 30% of your income when you could buy this G.O. school district rate and pocket the difference?"

 
Exactly!
Jan 7, 2010 11:50 am
buyandhold:

The next big financial crisis is going to be the states running out of money. Happening in California, New York, a lot of states got through 2009 by using stimulus money from the feds. I don't know how that will impact munis, but it's a concern. .... Personally I would rather lend money to Coca Cola or JNJ than a municipality. .... I've got a client with some California munis that I worry about. Yeah, California has a clause in their constitution that puts the munis at the top of the list when the bills comes due, you know they'll have a referendum to stiff the bond holders so they can pay float people like that guy on here a few weeks ago who was retiring with a 100k annual state pension for riding around in a fire truck.

 
The reason there is still opportunity in the muni market.
Jan 7, 2010 12:14 pm
BondGuy:
buyandhold:

The next big financial crisis is going to be the states running out of money. Happening in California, New York, a lot of states got through 2009 by using stimulus money from the feds. I don't know how that will impact munis, but it's a concern. .... Personally I would rather lend money to Coca Cola or JNJ than a municipality. .... I've got a client with some California munis that I worry about. Yeah, California has a clause in their constitution that puts the munis at the top of the list when the bills comes due, you know they'll have a referendum to stiff the bond holders so they can pay float people like that guy on here a few weeks ago who was retiring with a 100k annual state pension for riding around in a fire truck.

 
The reason there is still opportunity in the muni market.
 
Are you saying his perception of the risks in the muni bond market are inaccurate? 
 
Jan 7, 2010 12:25 pm
snaggletooth:
B24:
Muni UIT's yielding 6.5% net of fees?  First off, you can't reinvest them at the same yield (muni's yielding 6.5%, well, are no longer yielding 6.5%) as the market has pushed yields down.  Secondly, are these high yield muni's or CA only?  I just don't remember nationwide muni's yielding 6.5%.  But hey, maybe you know something I don't know.  Typically UIT's hold some great bonds, but the expenses push the yield down to a pretty average range.
 
Here is what I'm looking at:  https://www.ftportfolios.com/Broker/dp/dpsummary.aspx?fundid=6455
 
There are some HY and some CA, but not all of them.  And the monthly dividend is reinvested at current market price, so it could be 6.5% or higher or lower. 
 
There is some leverage, which is how they get the yield up there, but with the yield curve the way it is, it makes some sense to leverage in a sane way.
 
Trust me B24, I don't know anything you don't...for the most part.  But I know I don't know everything, so I'm still learning here.
 
OK, OK, OK.  Now I see what you're looking at.  They are CEF portfolios, not UIT's with individual investment-grade muni's.  Most of the CEF's are either high-yield (below investment grade), or use leverage.  Anytime you see "high-yield" "high-income" "strategic" "advantage", etc. it's usually a sign that they are using something beyond investment grade (and/or leverage).  You can use a basic high-yield muni fund and get the same yield.  Remember, CEF's often derive yield from capital gains, based on how they are structured, so the NAV is slowly depleted over time.
Jan 7, 2010 4:20 pm
Spaceman Spiff:
BondGuy:
buyandhold:

The next big financial crisis is going to be the states running out of money. Happening in California, New York, a lot of states got through 2009 by using stimulus money from the feds. I don't know how that will impact munis, but it's a concern. .... Personally I would rather lend money to Coca Cola or JNJ than a municipality. .... I've got a client with some California munis that I worry about. Yeah, California has a clause in their constitution that puts the munis at the top of the list when the bills comes due, you know they'll have a referendum to stiff the bond holders so they can pay float people like that guy on here a few weeks ago who was retiring with a 100k annual state pension for riding around in a fire truck.

 
The reason there is still opportunity in the muni market.
 
Are you saying his perception of the risks in the muni bond market are inaccurate? 
 
 
I'm saying it takes diverse interpretation of those risks to make a market. If we all agreed, along with having a boring world, there would be no market.
Jan 7, 2010 6:38 pm

What a great thread!

BG, are you selling CA bonds to clients?

Or maybe I should ask it this way...are you avoiding CA bonds? Why or why not?

(Anyone else can answer, I just have a mancrush on BG)

Jan 7, 2010 10:51 pm

OK. I have bought quite a few munis in the last year.



As a preface, I have traditionally bought individual bonds for most clients.



The big risk going forward as everyone here knows is rate increases, BIG increases. We cannot print money like Al Capone w/o paying the piper. I do not expect there is one chance that the fed will raise rates before the mid term elections, it will be suicide for Bernanke to do that will the dems in the position they are in.



I also do not think inflation will be of any major concern for some time. I was allocating to tips in my managed ETF models, but I am rethinking things. Two reasons. 10% of the population is out of work, with that much unemployment there will be little chance of consumers fueling 5-10% CPI growth. Second involves foreign investment. With the impending collapse of the dollar we cannot expect a surge of foreign demand for dollar based goods.



We are also on the verge of a 44% increase in the top tax bracket combined with the continued "evilacation" of success and wealth. That will suppress demand and fuel demand for munis.



Where would I be concerned or concentrated now? Short term munis on my sell list. The short end of the curve will be the first to go, and those are the ones that think they are the safest- 1-3 yr paper (funds that is, not individuals). The intermediate term stuff, say 6-12 yrs, will probably be ok. You are getting a reasonable rate of return and will probably not see a large decline in principal. Lets keep in mind that Muni rates are actually reasonable compared to taxable paper. They have not dropped and quite a few are actually higher (rate) than 2007. That will help hold prices when taxable equivalents come to parody. Long term will possibly serve people well. Hard to say. I think they are still priced attractive and with expected high demand due to tax increases should keep them from demise. I have heard the "death" of long term munis for some time. At the end of the day we are following all other mature economies. Over time our rates are getting lower and lower. They have to. We cannot keep growing as a country at high GDP/CPI rates forever.



Muni defaults. They will happen. Jefferson county AL will be a big one. Worst part is it is an essential services issue. I would give their water authority notes 1 to 2 years at best. That will really hurt short term as people re-adjust their RTA. The Cali model will follow- decent price decline followed by return to realization. Lets face it, Cali GO's were the best muni buy in a decade. By state constitution and covenant on the bond they cannot default until the lay off every employee of the state save teachers. Basically they have to pay teachers, then the bonds, then ANY OTHER BILLS OF THE STATE. Pretty safe in my world. Plus you got that whole little fact that by law a state CANNOT declare BK, period. We will have some default here and there, but not widespread. If you buy individuals stay with GO's and essential services. Here is where I start buying funds. No not Ron Felding and his crap (I know he retired). I am talking about Joe Deane (Legg), Franklin, Lord Abbett and other quality shops. They will dance the known problems and help play the curve plus diversify you. It is a great swap right now. "Mr Jones, we have made good money over the last year, lets book the profit and play safe" Plus you get paid (in general you don't holding a bond to maturity).



What am I doing? I am selling my individual bonds and trying to move people to templeton foreign bond. As the dollar declines, sovereign debt in foreign denominated currencies will appreciate. I am also moving into floating rates. Sh*tty place to be in a declining rate environment, but great to have in a rising one. Buy funds to replace the individual bonds with the same timeline. Joe D at Legg is brilliant in this environment. He hedges against rising rates. For those who staunchly say "I don't buy funds!", remind them that they also never though C, BAC, Fannie, Freddie, AIG and nearly every other financial company would, for all intents and purposes, go BK at the same time. Time to get over those preconceptions or be the next deer caught in the headlights.



Sorry for the ramble- a lot of thought on a complex topic.....