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A Taste for Junk

Sonja Haggert

BONDS ARE IN THE NEWS again. Everyone’s talking about Series I savings bonds and Treasurys. But what about corporate bonds, both investment-grade and junk?

Nine years ago, we started following Marc Lichtenfeld’s investment service that recommends corporate bonds. When my husband suggested we try it, I asked, “Aren’t corporate bonds junk bonds?” Forgive the holiday reference, but I had visions of Michael Milken dancing in my head.

From the beginning, my husband was all in. He was intrigued by the high rates corporates would pay and the opportunity for diversification. I was concerned about the risk. Once we got started, though, I found a lot to like.

Corporate bonds carry ratings that help distinguish their creditworthiness. Three credit rating agencies—Moody’s, Standard & Poor’s and Fitch—sort corporates into investment grade, speculative grade, likely to default and defaulting. Each tier has a corresponding letter grade, from AAA to D.

Bond buyers can look up the gradations among the three rating agencies to understand what each rating means for any given bond. In general, a top rating of AAA is reserved for U.S. Treasurys and the strongest blue-chip companies. Investment-grade corporate bonds can get grades ranging from AA+ to BBB-. Anything lower is speculative or not investment grade—junk, in other words.

We compromised by buying investment-grade bonds at first. Gradually, we ventured further into the depths of junk, even buying C- and D-rated bonds as time went on. These are the bottom rungs of junk. A grade of D, for example, usually signifies “in default.”

How, then, have our junk bonds held up? Surprisingly well. For a risk-averse investor like me, a crucial selling point was their relatively low default rate of 2.5% to 3.5%.

High-yield bonds have also posted sturdy returns, according to Bloomberg data cited by money manager Hotchkis & Wiley. The average annualized return on high-yield bonds between 1986 and 2021 was 7.3% during periods of rising interest rates and 8.5% in periods of falling rates. Investment-grade bonds, by contrast, returned less—just 1.2%—in periods of rising rates and more—9.9%—in periods of falling rates.

Why did we buy individual bonds rather than bond funds? When interest rates rise, as they have this year, the share prices of bond funds fall. The market discounts the lower-yielding bonds in the fund’s portfolio until their yield equals the higher rates on offer by newly issued bonds. The share-price decline can be even larger for closed-end funds that use leverage, or borrowed money, to juice their returns.

The price of individual bonds, of course, also falls when interest rates rise. But we aren’t bothered. Our intent is to hold our bonds until maturity. That way, we collect the interest from bond coupons until we are paid back our principal at maturity. Occasionally, a bond we own may get repaid early—or “called.” If we’re lucky, the bond in question gets redeemed at a premium to its current market price.

Our bond investment service has guidelines that match our objectives. Bonds are selected based on “coverage”—the ability of the company to generate sufficient cash flow, or which has adequate funds, to make coupon payments during the time we’ll own them. In addition to the interest payments, paid at a minimum every six months, we can occasionally buy bonds at a discount, which can give us a capital gain if their prices recover.

Today, we have a portfolio of bonds that yield anywhere from 3% to 16%. The higher payouts mean higher risk. Two-thirds of our bonds are non-investment grade, or junk. Our current portfolio includes bonds maturing every year for the next five years.

Overall, we’re doing well, although we do own some disappointments, such as Revlon. Did you think we wouldn’t have some clunkers amid all this junk? There’s lots of bad news about Revlon. From the start, it was called distressed. Then came the bankruptcy filing. Then there was good news. Revlon was paying its bond coupons even in bankruptcy, so through it all we’ve been getting our scheduled interest payments.

We have no idea if Revlon can make it through intact, or whether it’ll be sold off or even liquidated. We did know what we were getting into when we bought, so we kept our investment small.

You could equate our fondness for junk bonds with junk food. We don’t eat it often, but when we do, we enjoy it. We’re usually aware of what we’re doing—and we try not to overdo it.

Sonja Haggert is the author of Invest, Reinvest, Rest. You can learn more at SonjaHaggert.com. Follow her on Twitter @SonjaHaggert and check out her earlier articles.

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